7 Commodity Plays To Consider

By Investopedia Staff | April 30, 2012 AAA

With a variety of asset classes becoming ever more correlated, investors have been looking towards alternative means of diversification. Moving beyond just stocks and bonds, portfolios have become sophisticated with new positions in a variety of unconventional plays. Commodities have become a more increasingly important piece of asset allocation. Funds such as the Market Vectors RVE Hard Assets Producers ETF (ARCA:HAP) have become popular with investors trying to access the sector. Nevertheless, given the popularity explosion of the commodities sector, correlations between stocks and commodities are becoming ever closer.

However, several natural resource alternatives that are often overlooked by retail investors can provide low correlations to traditional holdings. These "roads less traveled" and overlooked sectors may be the best ways to find uncorrelated assets in the commodities patch.

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Living Off the Land
When investors generally think of commodities, hard assets like gold, oil and corn come to mind. However, the trio of farmland, water and timber may be one of best ways to play the commodity space. Many of the same themes work for the trio as the overall commodities space. Exploding populations worldwide have added increased pressure on the planet's natural resources. This insatiable demand for hard assets is touching all aspects of modern living. Metals and other materials are needed to build infrastructure. Vast amounts of energy resources are needed to provide electricity and to power transportation. Soft commodities, such as corn and wheat, are needed to meet the world's growing middle class demand for meat and other foods.

Accounting for more than 14% of the world's economic output, commodities form the basis for all goods and services. By investing in farmland, water rights and timber, portfolios can still benefit from these trends without many of the volatility problems associated with commodities. In addition, their long term nature is perfect for retirement portfolios and produce truly uncorrelated results.

Farmland Plays
According to a recent study by Kansas State University, U.S. farmland since the 1950s produced an average annual return of 11.5%, when including crop yield and land appreciation. This compares to a 12% annualized total return for the broad stock market. Yet, the farmland investment produced less than half of the volatility of stocks. With rising global populations requiring more food to sustain themselves, investing in farmland could be a slam dunk. Only about 7% of the Earth's surface is suitable for cultivation, and according to the Food and Agriculture Organization (FAO) of the United Nations, arable land per capita worldwide has fallen from 1.2 acres in 1960 to just 0.55 acres today.

The dire need for food has already led many countries and investment firms to take action. China has recently spent about $5 billion in Africa to purchase fertile plots. Similarly, many investment banks have created farmland funds for land purchase. Both Cresud (Nasdaq:CRESY) and newly IPO'd Adecoagro (Nasdaq:AGRO) allow regular retail investors to add the asset class to a portfolio. Each owns a variety of farmland and farm operations in fertile South America, and will benefit from the worlds need for more food.

Water Investment
Investing in Blue Gold usually means buying industrial companies like Calgon Carbon (NYSE:CCC) or utilities like American Water Works (NYSE:AWK), not the physical water. PICO Holdings (Nasdaq:PICO), through its wholly-owned subsidiary Vidler Water, owns water rights in the states of Nevada, Arizona, Idaho, Colorado and New Mexico. The company generates revenue by selling its water resources to real estate developers, municipalities and industrial users.

Your Own TMO
Timber currently shows a correlation of -0.01 to large cap stocks, -0.36 to long term bonds and only a 0.12 correlation to standard commercial property. Investments in timber have also produced nearly 7% annualized returns over the past 10 years. For investors looking for a broad-based play on timberland, there are two ETFs in the sector. The Claymore/Beacon Global Timber Index (NYSE:CUT) and the iShares S&P Global Timber & Forestry (Nasdaq:WOOD) offer a diversified way to play the entire timber spectrum. Investors still might want to consider CUT over WOOD, due to its increased weighting in international stocks, including Fibria Celulose (NYSE:FBR).

The Bottom Line
As investors crave new levels of diversification, the ignored commodity trio of farmland, water rights and timber could be what investors are looking for. Their uncorrelated and long-term attributes make them perfect for retirement portfolios. The previous stocks and ETFs are perfect ways to add these hard to access asset classes to a portfolio. (For more stock analysis, see Canadian Oil Companies Set To Outperform.)

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