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| | Mutual Funds
Here's a bubble you can still buy
Commodities prices are climbing around the world, a phenomenon that'll likely continue for a while. Two well-run funds give investors a way to make money on the trend.
By Timothy Middleton
Two of the hottest tickets in Manhattan in February were "The Producers" on Broadway and a Morgan Stanley investment conference, both of which sold out. Both were about high drama in low investment places, the show about Broadway itself and the conference about basic materials.
Were talking concrete, copper pipe and lots of steel. If that doesnt sound sexy to you, youre not paying attention. The crush outside the Morgan Stanley conference door reminded some of a similar standing-room-only meeting the investment bank held almost exactly four years earlier. That one was called Networks, Internet and Software.
We have us a bubble here, folks, but unlike that Internet thing this one is just beginning. Computers and natural resources are both cyclical industries, but they have radically different tempos. You can outsource a router to Singapore almost overnight; it takes years to dig a mine.
We have not added to productive capacity in most resources for several years, says Charles Ober, manager of T. Rowe Price New Era (PRNEX), one of the longest-tenured managers in this newly popular sector. Theres a window of at least three to five years before a lot more capacity comes on to satisfy what we see as growing demand.
Demand is growing throughout the world, and nowhere more than in China, whose gross domestic product skyrocketed at a 9.7% rate in the first quarter and whose infrastructure building has created the fastest-growing market for energy and materials.
Running past the market
The average natural resources mutual fund has surged 43.4% in the 12 months ended March 31, which was 830 basis points more than the S&P 500 Index ($INX).
My colleague Jim Jubak has devoted columns recently to the energy sector, which is the largest constituent of natural resources, but the investment opportunities spill over into other categories, notably industrial metals.
That makes mutual funds an ideal way to approach the group. And I mean good, old-fashioned actively managed funds. This is a hard bunch to index. Funds like Obers, however, and RS Global Natural Resources (RSNRX) are in a position to outperform the market for a good long while.
Ober has run the Price fund for more than seven years, having taken it over from George Roche when the latter was named Prices chairman in 1997. Roche had run the fund from inception in 1969. The manager of the average resources fund has less than five years experience.
The Price fund is distinguished from the usual portfolio in the group by thorough diversification. Its average rival holds 70 cents of every dollar in the energy business; this fund has barely more than half. Its one of only a handful of funds that offers investors truly diversified natural resource equity exposure, and it has done so very consistently, says Morningstar analyst Langdon Healy.
Currently, the fund has nearly 20% of assets in metals, including gold, and nearly 10% in paper and forest products companies.
A different approach
Andrew Pilara has an even longer record at RS Global Natural Resources, having run the fund since inception in 1995. His record is just as distinguished as Obers, and currently hes even more diversified, having only 40% of assets in energy.
| Allocations | | Fund | Energy | Materials | Non-US Stocks | 12-mo. perf. | | T. Rowe Price New Era (PRNEX) | 56% | 34% | 24% | 43.8% | | RS Global Natural Resources (RSNRX) | 40% | 52% | 53% | 50.7% |
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Notes: As of 3/31/04.
Source: Morningstar Inc.
The RS funds broad exposure to commodities also differs from Price in focusing on smaller names in the oil patch, such as Unocal (UCL, news, msgs), one-thirtieth the size of Exxon Mobil (XOM, news, msgs), which is Obers top name.
Last year, Pilara greatly benefited from overweighting such basic materials as metals and agricultural products. But he consistently manages his fund unconventionally, making major bets on themes his peers ignore. The fund is one of the least-correlated with the S&P 500 in its category, making it an attractive diversifier, says Morningstar analyst Lynn Russell.
| Top holdings | | Fund | Top holdings | | T. Rowe Price New Era (PRNEX) | Exxon Mobil (XOM, news, msgs) | | Devon Energy (DVN, news, msgs) | | Newmont Mining (NEM, news, msgs) | | Murphy Oil (MUR, news, msgs) | | ChevronTexaco (CVX, news, msgs) | | RS Global Natural Resources (RSNRX) | Canadian National Railway (CNI, news, msgs) | | Sherritt International (SHERF, news, msgs) | | Placer Dome (PDG, news, msgs) | | Slocan Forest (SLCFF, news, msgs) | | Unocal (UCL, news, msgs) |
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Note: As of 12/31/03.
Source: Morningstar Inc.
Inflation protection
Index funds are available in natural resources, including exchange-traded funds, but I dont like them. iShares Dow Jones U.S. Basic Materials Fund (IYM, news, msgs), for example, has more than 50% of assets in chemicals, and more than a quarter in just two names, DuPont (DD, news, msgs) and Dow Chemical (DOW, news, msgs).
Rather than benefiting from higher energy prices, chemical companies are hurt because they rely on oil and natural gas both as feedstocks and fuel. My two favorite active managers are staying away from the group for that reason.
Commodities prices offer excellent inflation protection, and resources stocks are benefiting from a growing concern that inflation is rapidly becoming a problem again. When the governments recent report of a 0.4% surge in the March core domestic inflation rate hit the tape, bonds were devastated.
The Price fund had the strongest performance in its history during the Carter administration, when inflation was raging, racking up back-to-back gains of more than 50% in 1979 and 1980.
Today, however, global markets, rather than the domestic economy, are driving higher commodity prices; as the marginal buyer, China effectively sets their price, although Russia and India are also major contributors. And with China laboring under a fantastic burden of debt -- as much of 40% of its bank loans may be nonperforming -- the commodities bubble could be burst in Beijing.
By the same token, some analysts use the same facts to argue China wont burst the bubble, precisely because its borrowers dont plan to repay anyway and therefore are immune to rising interest rates, which loom in the East as surely as in the West.
So take your choice: Either resources stocks are so expensive theyre ripe for a fall, or theyre expensive because they're paying off, hitting the lengthy sweet spot of their cycle.
My vote is cast alongside Jubaks. I plan to move a portion of my personal assets into one or the other of these funds. I think theyll do better than diversified U.S. equities for at least a couple of years.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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