Natural Resources

Natural resources, from forests and farms to oil, copper and wheat, give portfolios exposure to real goods whose prices respond to supply shocks and inflation. This module explains how land-based investments earn their returns, how commodity futures are priced, how a futures investor's return splits into spot, roll and collateral components, and when natural resources do, and do not, protect a portfolio.

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What you will learn

1. Describe the investment features of raw land, timberland and farmland and the sources of their returns.

Raw land: value from future development options; little income, holding costs.
Timberland returns: biological growth + timber price changes + land value changes.
Harvest flexibility lets timber owners delay cutting when prices are low; crops cannot be delayed.
Farmland returns: crop income or rent + land appreciation; row crops versus permanent crops.
Common drawbacks: illiquidity, appraisal valuation, location and weather risk, need for specialist operators.

2. Describe the main commodity sectors and ways to invest in them, and explain how futures prices relate to spot prices, including contango and backwardation.

Sectors: energy, industrial and precious metals, agriculture (grains, softs, livestock).
Exposure via futures and index products is most common; producer equities add company and market risk.
Futures price is roughly spot x (1 + r) + storage costs - convenience yield.
Contango (futures above spot) with ample inventories; backwardation (futures below spot) with scarce inventories.
Curve theories: insurance (normal backwardation), hedging pressure, storage.

3. Calculate the return on a fully collateralized commodity futures position and decompose it into price, roll and collateral returns.

Fully collateralized: futures exposure backed by an equal amount of T-bills, so no leverage.
Total return is approximately price return + roll return + collateral return.
Roll return = (expiring price - new contract price) / expiring price.
Backwardation gives positive roll returns; contango gives negative roll returns.
Collateral return rises with short-term interest rates.

4. Explain the risk, return, diversification and inflation-hedging characteristics of natural resource investments, including environmental and social considerations.

Commodities earn price, roll and collateral returns; land earns income plus appreciation.
Commodities tend to rise with unexpected, supply-driven inflation, when stocks and nominal bonds suffer.
Low long-run correlations, but correlations can rise in broad demand shocks.
Risks: volatility, supply shocks, contango, illiquidity, weather, water and regulation.
Environmental and social issues (deforestation, water, climate transition) affect long-term value.

Module at a glance

Timberland returns come from biological growth, timber prices and land values; harvest flexibility is a valuable option.
Farmland returns come from crop income or rent plus land appreciation; crops cannot wait to be harvested.
Futures price is roughly spot x (1 + r) + storage - convenience yield.
Contango means futures above spot and negative roll returns; backwardation means the opposite.
Fully collateralized futures return = price return + roll return + collateral return.
Commodities hedge unexpected, supply-driven inflation; correlations can rise in demand shocks.
Environmental and social factors such as deforestation, water use and climate transition affect long-term value.

This free module has 4 lessons, 12 practice questions with full explanations.

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