Understanding Commodities, Farmland, and Timberland
Natural resources are assets that occur in nature and can be used for economic gain. As an alternative investment class, they include commodities, timberland, and farmland. These investments require specialized knowledge due to their unique characteristics and are increasingly gaining attention due to factors like population growth and ESG considerations.
While both are land investments, farmland and timberland have distinct features compared to traditional real estate.
Food Production Focus
Driven by the basic need for food, farmland generates returns from crop price changes and land appreciation. It is often family-owned and has shorter production cycles.
Investment Methods: Direct (owning a farm) or indirect (through funds or REITs)
Biological Growth
Returns are generated from timber price changes and the biological growth of trees. It offers flexibility in harvesting, allowing owners to wait for favorable market conditions.
ESG Benefits: Carbon sequestration and environmental sustainability
Commodities are raw materials or primary agricultural products that can be bought and sold. They are standardized and grouped into sectors like energy, precious metals, and grains.
Directly holding physical commodities involves significant storage and insurance costs. Therefore, most investors gain exposure through derivatives:
Provide direct exposure to commodity price movements through standardized contracts.
Give the right but not obligation to buy/sell commodities at specified prices.
Funds that trade on exchanges and track commodity prices or baskets.
Funds managed by Commodity Trading Advisors using futures market strategies.
The price of a commodity futures contract is linked to the spot price through the concept of "cost of carry."
Includes:
The benefit of holding the physical commodity (e.g., to avoid a production stoppage).
When the futures price is higher than the spot price. This is a typical situation where the cost of carry is positive.
Can lead to "negative roll yield" (selling cheaper expiring contracts and buying more expensive new ones).
When the futures price is lower than the spot price. This occurs when the convenience yield is very high, outweighing the cost of carry.
Can lead to "positive roll yield" (selling more expensive expiring contracts and buying cheaper new ones).
Natural resources offer unique risk-return profiles and valuable portfolio characteristics.
Prices are highly volatile and sensitive to supply and demand dynamics, which can be affected by economic cycles, weather, and geopolitical events.
Returns are influenced by commodity prices, but also by factors like land quality, forest growth cycles, and operational efficiency.
Natural resources provide powerful diversification benefits and inflation protection that can enhance overall portfolio resilience and risk-adjusted returns.
Low Correlation
Commodities, farmland, and timberland have all shown low correlation to traditional stocks and bonds, making them effective portfolio diversifiers that can enhance risk-adjusted returns.
Price Protection
As raw materials, commodity prices often rise with inflation. This makes them a strong hedge against unexpected increases in the general price level. Farmland and timberland also provide a modest inflation hedge.
Global Exposure
Supply/Demand Dynamics
ESG Considerations