Investing Guides: Tips And Advice For Investing In Natural Resources

Investing in natural resources has many advantages and pitfalls. Learn how to invest safely and wisely.

Natural resources are all around us. They are found in the foods we eat, the cars we drive, and the houses we raise our children in. Natural resources, including oil, coal, gold, silver, timber, copper, and a host of other commodities, go through long cycles of price rises and falls, depending on supply, demand, the economy, and the strength of the dollar (the currency in which most resources are priced) compared to other currencies. For the investor who wants to be a part of the enormous and essential market for natural resources worldwide, there are three main vehicles available: physical holdings, stocks, and futures.

One popular way to invest in natural resources is to buy those resources themselves. Now most of us do not have storage facilities for storing oil or coal or pork bellies, but precious metals, like gold and silver, are easy to buy and store, and (most importantly) are easy to sell when it's time to cash in your winnings. They have what's known as a liquid market, and there are many good places, from your local coin store to internet or mail order companies, where you can buy or sell them.

Gold and silver coins come in several types. The most famous is "numismatic" coins, those which have value to collectors. If you're simply interested in the metals themselves, these are coins which should generally be avoided. They are an expert's market, and the fact that they are rare (their rarity is what makes them valuable), also makes it easy to overpay but difficult to get your money back. If you want to purchase collector's coins, be certain that you understand the market. They are not natural resources, but collectibles. Do not be fooled by a dealer who wants to move you from one category to the other.

For the person who just wants to own a little gold or silver, the best vehicle is what is known are bullion coins or bars. For simplicity, I'll just explain silver, as the principles here can mostly be applied to whatever metals you want to buy, from gold to platinum to palladium.

Silver can be purchased in sizes from a 5000-ounce bar all the way down to a pre-1965 dime. One will cost nearly $40,000 dollars, the other less than fifty cents. So what are the differences? Size, purity, and liquidity.

Silver bullion bars are generally 99.99% silver (known as .9999 or "four nines" pure). They range in size from one ounce to 5000 ounces. They are the purest way to own silver, but if you get into the larger denominations, storage will become an issue. Just remember before you buy that you must have a place to put your purchase. A 5000 ounce bar of silver weighs 70 pounds! That will probably not fit in your safety deposit box.

Silver bullion can also be purchased in coin form. The most famous is the American Eagle coin, a one-ounce coin with Lady Liberty on the obverse (front), struck by the United States Mint. They are pure and liquid, though they will generally cost more than the "spot" or market price. Other government-issued silver coins include the Maple Leaf (Canada) and the Libertad (Mexico). Some European and Asian governments issues silver bullion coins as well, as do private mints, like Sunshine or the Wall Street Mint. Private issue coins will cost less, but are less liquid than their government-issued counterparts.

A very popular way to accumulate silver is through what is known as "junk" coinage. These are coins, generally American dimes, quarters, and halves, issued before 1965. They are 90% silver, and will occasionally turn up in your change. They can be purchased by the roll or in $1000 face value bags and a multiple of "face" value (for example, $1000 in dimes may cost $5000). One advantage to junk silver is that you can buy a little at a time, and you can buy it from coin shows, coin stores, through internet auctions"┬Žsome people even put ads in the local paper to buy it.

When purchasing resources, especially metals, for physical storage, the important things to remember are liquidity and storage. Whatever you buy must be kept safe from theft or fire, and you must also be able to sell it. Always be sure you understand to whom you will sell when the time comes and how much you'll be able to get for it. The more liquid a market is, the smaller the spread, so you'll pay less and get more for your investment. Markets like gold and silver are liquid. Molybdenum, copper, and platinum, while they may go up in price, are going to prove a challenge when the time comes for you to sell.

Of course, physical holding of natural resources is not limited to precious metals. You can buy or lease acres that can harvested for timber or drilled for natural gas, and you can even raise pigs for pork bellies. In each case, physical holdings of natural resources are the longest-term investment and the most illiquid. It's a lot easier to sell a stock than a pig!

Now, if you've decided that you don't want to physically hold resources, a second way to own them is by owning shares of the companies that produce or explore for them, like miners or oil companies. In this case, companies own the cattle on the hoof or the gold in the ground, and you own them by owning a part of the company.

Stocks have the advantage of being easy to store, but they have the disadvantage that every other company has: a certain amount of the production must go to pay salaries and taxes and overhead.

But there is an advantage to owning stocks that do not accrue to owning the physical resource: leverage.

Let's say you have a gold miner that can produce 10 ounces of gold a year at a cost of $450 per ounce (we'll make it small so the math is easy). With gold at $500, it will earn $50/ounce times 10 ounces, or $500. If gold rises to $550, however, it will earn $100 per ounce, or $1000. Where your physical gold has gone up 10% in price, your mining company's profit has doubled. But remember, leverage works both ways. You can lose money just as fast as you can earn it, and for every fortune made in resource stocks there's another one lost. The same principle applies to harvesting companies, small oil producers, and coal miners. When times are good, they are very good. When times are bad, they are very bad.

The above applies to producing companies, those that actually pump oil, mine gold, or harvest timber, but there is a second category that offers even higher leverage: exploration stocks. These are companies that may not have any gold or oil but are looking for it. Or they may have a small deposit that they are trying to develop to sell it to a larger company. This is an expert's market, but there is no higher leverage than in a small company that finds a significant gold or natural gas deposit.

One caveat: Mark Twain once said that a gold mine was a hole in the ground with a liar standing next to it. Perhaps he was a little harsh, but there's no doubt that many exploration companies will not find anything that can be sold or produced. I heartily suggest you talk with your financial advisor and research any company yourself before you purchase its stock.

The final option for investing in natural resources is through futures and options. In this case, the investor buys or sells a contract to deliver or receive a certain amount of resource on a certain date, hoping the price will go up before the contract expires. The contracts are traded in a separate market from stocks, like the Chicago Mercantile Exchange, and they are very short term investments compared to stocks or physical holdings of resources.

Options and futures are usually traded through specialty brokers on a leveraged basis and most investors' contracts are never delivered, but settled in cash at the end of the contract period. It is recommended that, due to the extreme leverage and short-term time frame involved, you seek out competent financial advice before venturing into the futures market.

The investor who is interested in natural resources has many resources to choose from and many vehicles through which he may invest. It might be easiest to summarize them this way:

Physical commodities offer safety and low leverage, but have storage issues. Stocks offer some leverage, may be held either long or short term, and avoid storage issues. Futures and Options offer extreme leverage and are very short-term investments.

As with any investment, talk to your financial advisor, but seek one who has knowledge in natural resource areas. The fact that the market is cyclical, having long periods where resources are either desired or avoided by the public, means that there are a lot of brokers who may not be familiar with these markets, depending upon which part of the cycle the current market finds itself. Seeking competent financial counsel will greatly increase your chances at succeeding in the natural resource markets.

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