Topic: Energy Stocks

Resource stocks have potential as a hedge against inflation

Government efforts now underway are likely to solve today’s financial crisis. But the cure will likely only come at a cost of much higher inflation, starting possibly in the next decade.

We’ve been asked by a number of investors how this should influence their investing. Many have asked specifically about resource stocks.

As a general rule, resource stocks will provide a hedge against inflation, because they gain directly from rising prices for the commodities they produce.

But while we think you should maintain some exposure in resource stocks, you should still aim for balance among all five sectors: Resources & Commodities, Finance, Manufacturing & Industry, Utilities and the Consumer sector. You should always resist the temptation to load up on resource stocks (or on stocks that trade at high p/e ratios or high ratios of stock price to sales). If the market does go into a downturn, these stocks will suffer more than average.

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There’s a wide variety of resource stocks to choose from. Resource stocks can include companies that mine or drill for resources, as well as those that convert them into a useable form. For example, Imperial Oil produces oil and natural gas. But it also has substantial refining operations that produce gasoline and other petroleum products.

Agrium is another example of a resource stock. The company is a leading global fertilizer producer and marketer. It also runs a chain of retail stores that sell agricultural products in the U.S., Argentina and Chile. Nitrogen, phosphate, and potash, which are ingredients in fertilizer, are “mined.”

While the recession has temporarily slowed down growth in the Chinese economy, China will have a positive impact in the long term on some commodity prices and resource stocks. For instance, China is a major importer of oil and other resources.

I think a well-designed investment portfolio should include some stocks from the resource sector. But don’t get carried away with these. There are many undeveloped mineral properties in China and Russia that are going to get a close look if commodity prices continue to creep back upward over the next few years, especially if interest rates stay (relatively) low, as I expect.

For that matter, resource stocks (and this includes oil and gas, of course) should also make up only a limited portion of your portfolio — say less than 20% for a conservative investor or as much as 30% for an aggressive investor.

One more general rule: if people generally believe the price of a resource is sure to go up, the reverse often happens. That’s because resource producers and those who use their products also read the newspapers, and they both take steps to protect themselves and profit from the situation. The suppliers try to increase supplies, and the users try to become more efficient or find alternative commodities.