ALT 5 Natural Resources

Natural resources cover two broad things: commodities, and raw land put to agricultural use through farming and timber. The asset class is showing up in more portfolios, and access has broadened well beyond direct ownership: exchange-traded funds, limited partnerships, REITs, swaps, and futures all provide indirect exposure. Managing the class well takes specialist knowledge of how each resource actually earns its return.

Familiar names like crude oil, soybeans, copper, and gold fall into two families. Hard commodities are mined (copper) or extracted (oil). Soft commodities are grown over time, for example livestock, grains, and cash crops like coffee.

What drives the return

The three land types differ most in where their return comes from. Raw land earns strictly from price changes in the asset itself; it has no inherent income stream, so returns accrue purely from appreciation. Farmland and timberland add an income stream on top of price changes: crops in one case, harvested trees in the other. The timing differs too. Timber can be cut whenever the owner chooses, while farm crops come off the land on a fixed cycle and have to be picked at ripeness, leaving little room to time the harvest.

Land compared with real estate

Farmland, timberland, and raw land resemble real estate in several ways: each is a unique, illiquid asset tied to a specific location, and each represents a form of ownership capital, meaning a claim on residual cash flows. Developed real estate and farmland can also carry steady lease income. The differences matter more, though. With land there is limited or no focus on physical improvements; value flows from the quality of the soil, the climate for growing (farmland and timberland), or the geology (mineral rights), rather than from buildings and development. Location still counts, because proximity to transportation and markets lifts the price, and for farmland and timberland the cost of moving the product can be a large part of what the end user pays.

Direct land investment also demands resource-specific expertise. An investor in timberland needs the skill to manage a forest across its life cycle, and institutions that lack it rely on timberland investment management organizations (TIMOs), which analyze and acquire suitable holdings on their behalf. Financing choices are narrower than in real estate, often limited to bank loans or private debt, and the small pool of qualified buyers and sellers keeps these assets illiquid. Roughly half of the private investable timberland worldwide sits in the United States, with Central and Eastern Europe, Latin America, Australia, and New Zealand next in size.

Features and forms of farmland and timberland

Interest in these assets is durable for simple reasons: everyone eats and needs shelter, crops throw off recurring income, holding land offers inflation protection, and the assets sit somewhat apart from financial market swings. US farmland, for instance, posted positive returns both when US GDP fell sharply (1973 to 1975 and 2007 to 2009) and when inflation ran high (1915 to 1920, 1940 to 1951, and 1967 to 1981).

Timberland has been a fixture in institutional and ultra-wealthy portfolios for decades, usually trading in large blocks of several thousand acres or hectares, and its main drawback is a long market cycle, sharpest for new-growth forest. Farmland trades in much smaller units, from tens to a few hundred acres or hectares, and stays largely family owned; 98% of US farmland is held that way, and globally farmland remains a core source of family wealth. Farmland runs to row crops that are planted and harvested (sometimes more than once a year), permanent crops on trees or vines, and pastureland for livestock. Timberland behaves like a factory and a warehouse at once: trees grow as output, and simply leaving them standing stores that output, so owners can harvest when lumber prices are strong and wait when prices are weak.

Direct ownership was the original dominant form, favored by tax-exempt investors with long horizons, namely pension funds, foundations, and endowments. Smaller investors reach these assets mainly through funds, whether public REITs in the United States or private limited partnerships, and direct timberland owners lean on TIMOs, often paired with limited partnerships, limited liability corporations, and private REITs. Larger investors still buy directly where an asset appeals, as Middle Eastern sovereign wealth funds have done with farmland in Africa and Southeast Asia. Separately managed accounts commonly split into two models: an owner rents out land used for row crops and receives fixed cash flows, while an owner-operator keeps operating control of permanent-crop properties such as orchards and vineyards, earns variable cash flows, and carries some operating risk.

Holding farmland directly gives access to a broader range of foodstuffs (spices, nuts, fruits, vegetables) than the corn, soy, and wheat available through futures, but price information is thin without sector specialists, and direct holdings are illiquid. On risk, farmland is highly exposed to unexpected weather and climate shifts that can wipe out a crop and its revenue across an entire growing season. Because a farm holds an inherent long position in its crop, it can sell agricultural futures for delivery at harvest to lock in a hedged return. These assets carry indirect value too: growing plants absorb carbon, so worth comes partly from the carbon offset; water rights and conservation easements add further value; and demand for arable land may climb as ESG-focused investing grows.

Commodities themselves throw off no cash flow, and they usually run up costs of carry: transportation, storage, and insurance for the physical goods. Investors are betting on price appreciation in excess of those carry costs, based on a commodity’s future economic value rather than on any intention to use it.

Governments loom large in these markets. Many subsidize food prices for consumers and support prices for farmers, and many control extractable rights outright. SOCAR, the fully state-owned oil and gas company of Azerbaijan, extracts oil and gas from onshore and offshore Caspian fields, runs the country’s only refinery and several export pipelines, and is a major source of national income. In many places a landowner may cultivate the surface yet the government retains subsurface rights to oil, gas, coal, gold, and silver. Environmental policy adds another layer: efforts to cut reliance on fossil fuels and expand renewables (wind, solar, biomass) have shifted attention to electric vehicles and batteries, lifting demand for minerals such as lithium, cobalt, and nickel, and the mining of those metals presses on local water systems, ecosystems, and communities.

Distinguishing characteristics

Commodity sectors span precious and base (industrial) metals, energy, and agriculture, and the mix of what matters changes as technology and preferences move: advanced phones and electric cars generate appetite for new materials while killing off demand for older ones. Commodities are also sorted by physical location and by grade or quality, so a derivative contract has to pin down quantity, quality, the maturity date, and where delivery takes place.

Investing through derivatives

Most commodity investing runs through derivatives, because holding the physical good invites tax obligations plus storage, insurance, brokerage, and transportation costs, and physical markets offer little price transparency. Futures and forwards do the bulk of the work, with options on futures used occasionally. Because these instruments trade on organized exchanges, they are liquid and support price discovery. A futures contract is an obligation to buy or sell a set amount of a commodity at a fixed price, location, and date; it trades on an exchange, is repriced to market each day, and may or may not end in physical delivery. That delivery obligation turns critical under stress: as demand collapsed during the 2008 global financial crisis and again in the 2020 COVID-19 pandemic, oil producers could not find buyers and storage filled abruptly, and even some commodity ETFs were forced to close and impose heavy losses. Counterparty risk on futures is handled by the settlement mechanism that links the clearinghouse or exchange with the clearing brokers.

Exposure can also be built without trading commodities or their derivatives directly:

• Exchange-traded products. ETPs, whether funds (ETFs) or notes (ETNs), suit investors restricted to equity shares or seeking simple access through a brokerage account. They may hold commodities or commodity futures; the SPDR Gold Shares ETF, for example, aims to mirror the physical gold price by storing bullion in vaults, and held just under USD53 billion of gold as of December 2022. These products can apply leverage and can mimic either a long or a short (inverse or bearish) position, and they charge fees through an expense ratio.
• Commodity trading advisers. CTAs are managed futures funds that take directional positions in futures markets using technical and fundamental strategies. One might concentrate on a single commodity such as grains or spread across many, though modern CTAs often trade commodities, equities, fixed income, and foreign exchange together. Individual investors frequently use separately managed accounts (SMAs) tailored to their preferences.
• Specialized funds. Private energy partnerships resemble private equity funds and give institutions energy-sector exposure; management fees run between 1% and 3% of committed capital, and the funds typically last 10 years, with 1-year and 2-year extensions. Public energy mutual funds and unit trusts often focus on oil and gas, sometimes paying dividends from rents or gains, and may target upstream (drilling), midstream (refineries), or downstream (chemicals), with fees of 0.4% to 1%, in line with other public equity managers.

Direct commodity investment amounts to underwriting the acquisition, management, and extraction of the resource itself. It represents claims on physical assets rather than on equity (residual) or debt (fixed) cash flows, and it brings added financing and operating risk, plus extra illiquidity when the stake is privately held.

Because a commodity trades in both a physical cash market and a financial derivative market, its prices in the two must line up, or arbitrage would follow. The gap between the spot price and the derivative price equals the cost of carry: the opportunity cost of holding the asset, which mirrors the risk-free rate plus the expense of storing, moving, and insuring the physical good. An investor who holds the physical good therefore expects to be compensated with a forward price above the current cash price.

There can also be a non-cash reward for holding the physical commodity instead of a derivative. This convenience yield arises when participants prefer the physical good, for example to guarantee continuous access, and it tends to move inversely with inventory levels. Because the convenience yield is a benefit that accrues to the owner, it pulls the forward price down. Under continuous compounding the relationship is:

A simpler additive version captures the same intuition:

So the shape of the forward curve depends on which force wins: the cost of carry, c, or the convenience yield, i.

Two curve shapes

When the spot price sits above the forward prices, the market is in backwardation, and the forward curve slopes downward, or is inverted. For physically settled contracts this arises when a positive convenience yield makes owning the commodity outright worth more than the carry it costs. When the spot price sits below the forward prices, the market is in contango, with an upward-sloping curve, because ownership costs outrun the convenience yield. A useful rule of thumb: contango tends to drag on a long-only investor’s return, while backwardation tends to lift it.

The April 2020 crude oil market is a vivid illustration. That month NYMEX crude futures dropped beneath zero for the very first time, so sellers effectively paid buyers to take on oil exposure, as pandemic lockdowns erased demand, producers could not cut output quickly, and storage overflowed. Early in January 2020, US oil inventories were at their lowest in over a year and demand looked healthy, so owning oil outright was worth more than the carrying cost and the futures curve was in backwardation. By early May 2020, inventories had climbed toward all-time highs with demand still muted, carry costs overwhelmed any storage benefit, and the curve had flipped into contango.