Normally, income investors avoid resource stocks – and for good reason. They rarely provide decent cash flow and they are highly volatile.Brian Jackson
The late stages of an economic cycle are usually good times for resource companies. Prices of key materials move higher, usually pushed by inflation, and shares of the companies that produce them follow suit.
Although this is not a typical economic cycle, we're seeing some of that now. Copper is trading near three-year highs. Aluminum is at levels not seen since 2012. Oil has rebounded from its January, 2016, low of $29.67 (U.S.) and appears to be stabilizing in the $50 range. Lead is creeping higher. After a big drop in 2014-15, nickel is moving off its lows. Iron ore is following a similar pattern.
All of this is happening without the traditional driving force of inflation, which remains muted in most industrialized countries. What we're seeing is simply supply/demand forces at work.
In the case of copper, for example, one of the main catalysts for the price increase has been the growing emphasis by auto makers on electric cars. Copper is a prime component in the construction of the engines to power such vehicles. Aluminum is up in part because, according to a recent Forbes article, China has ordered the closing of some of its highest-polluting smelters, reducing domestic output by up to 10 per cent. Since China is the world's largest consumer of aluminum, that is significant.
Not every resource is benefiting. Thermal coal, for example, is flatlining. Potash prices remain far less than their 2008 highs of more than $800 a tonne. So the resource rally is not lifting all boats. But it's broad enough to be worth a close look.
Normally, income investors avoid resource stocks – and for good reason. They rarely provide decent cash flow and they are highly volatile. You have to be an adept trader to get in and out at the right time.
But right now, I see an opportunity for those who are willing to take on a higher degree of risk with a view to buying a security that offers both cash flow and potential for capital gain. It's the SPDR S&P Global Natural Resources ETF. Here are the details:
- Trading symbol/exchange: GNR-NYSE
- Recent price: $46.66 (U.S.)
- Annual payout: 92.53 cents (U.S.) (trailing 12 months)
- Yield: 2 per cent
- Risk rating: Higher risk
- The security: This exchange-traded fund, distributed by State Street Global Advisors, invests in 92 international large-cap stocks in three sectors: agriculture, energy and metals and mining. The largest holdings are Exxon Mobil Corp., BHP Billiton Ltd., Royal Dutch Shell PLC, Total SA and Glencore PLC.
- Why I like it: The ETF gives us exposure to the world’s greatest resource companies. It has been on a strong run this year, with a year-to-date gain in market value of 15 per cent. It has a reasonable expense ratio of 0.4 per cent and generates some cash flow.
- Portfolio highlights: About 60 per cent of the portfolio is in the materials sector, with 34 per cent in energy and the rest split between consumer staples and real estate. Geographic distribution favours North America, with about 31 per cent in the United States and 11 per cent in Canada. Britain has 16 per cent of the assets and Australia has about 11 per cent. The price-to-earnings ratio is 16.7.
- Risks: As mentioned, the resource sector is historically volatile, so there is more risk than income investors are used to. This is not a buy-and-hold security; it is for opportunistic investors only. Don’t expect to hold it for longer than a year, perhaps less.
- Distribution policy: Payments are made twice a year, in June and December. The amounts can vary significantly so this is not a security to buy if you need regular, predictable cash flow.
- Tax implications: As a U.S.-based ETF, distributions will be subject to a 15-per-cent withholding tax unless they are held in a registered retirement plan.
- Who it’s for: This ETF is suitable for investors who would like diversified exposure to the resource sector and are prepared to accept above-average risk.
- How to buy: The units trade actively on the New York Stock Exchange. Any broker can arrange a purchase.
- Summing up: This is an opportunity to take a position in a sector that is currently generating above average returns, albeit with enhanced risk. Ask your financial adviser if it is suitable for your account.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.