As the economy expands and inflation ticks up, investors will have to keep in mind the negative effects of rising prices and maybe look to hard-asset related investments and exchange traded funds to help maintain the purchasing power of their portfolios.
“Exposure to natural resources/commodities offers the potential advantage of offsetting some of the longer-term inflationary effects of economic expansion, which many investment professionals are forecasting given the new leadership in Washington,” Mark Carlson, FlexShares senior investment strategist, said in a note.
Many anticipate a period of U.S. economic growth ahead after President Donald Trump promised to enact a number of expansionary policies, such as tax cuts, deregulation and increased fiscal spending, all of which could add fuel to inflationary pressure.
Along with the promised supportive economic policies at home that could affect inflation, a number of foreign actions could also lead to incremental gains in prices for the most basic of goods.
“The case for natural resources/commodities in 2017 is made stronger by the anticipated stimulus from the Trump administration, the under investment in the space over the last several years, and OPEC’s actions to attempt to restrict crude output,” Carlson said. “While less of a headwind, concerns over a hard landing by the Chinese economy also helps make the case for natural resources/commodities.”
Consequently, hard assets could perform well when inflationary pressures rise, a scenario that could benefit equity-based exchange traded funds such as the FlexShares Morningstar Global Upstream Natural Resource Index Fund (NYSEArca: GUNR). GUNR provides exposure to the rising demand for natural resources and tracks global companies in the energy, metals and agriculture sectors, while maintaining a core exposure to the timberlands and water resources sectors.
When looking at the natural resources space and other hard asset producers, it is important to consider the various industries, such as the differences between the upstream and downstream components of the supply chain.
“In brief, upstream refers to resources still in the ground, while downstream resources are those being processed into intermediate or finished goods,” Carlson said. “An upstream focus offers a clear advantage since investors are in position to benefit from price increases, while those with downstream exposure will be negatively impacted since the cost of goods sold will increase, thereby decreasing profit margins.”
GUNR specifically identifies upstream natural resources equities based on a Morningstar industry classification system, with a balanced exposure to three traditional natural resource sectors, including agriculture, energy and metals. The ETF’s portfolio includes 30.2% metals, 30.0% agriculture and 27.5% energy, along with minor weights in water 5.4% and timber 5.3%.
For more information on the commodities market, visit our commodity ETFs category.
CORRECTION: How commodity price increases affect downstream exposure.