Commodities To Hate, But Own Anyway

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Goldman Sachs says buy commodities. Hedge funds are trimming their bets. What's an investor to do? Try buying stocks with exposure to unloved commodities like natural gas and coal.

Who's Right?

Bloomberg.com ran an interesting article about the confusion in the commodity market. The article's first sentence sums it up pretty well: “Hedge funds cut bets on a commodity rally to a four-year low on signs of surplus supply in everything from coffee to zinc before Goldman Sachs Group Inc. said prices had fallen too far and investors should buy.”

Instead of trying to follow this divergent advice, how about a look at commodities that aren't on most investors' radar screens.

Natural Gas

Natural gas prices in the United States remain at historically low levels. The reason is that new drilling techniques have unlocked reserves and created a supply glut. Low prices have led to utilities switching to natural gas over coal since low prices have made the fuel competitive for base load use. Meanwhile, with low prices, drillers are focusing their efforts on their more profitable oil activities, which will eventually limit supply.

So, supply and demand will line up at some point and natural gas prices, over the long term, are likely to rise. Investors interested in the space might want to consider two oil majors that have been increasing their exposure to natural gas in recent years: ExxonMobil (NYSE: XOM) and Royal Dutch Shell (NYSE: RDS-B).

These two companies are international energy giants with widely diversified businesses. This provides a shield of sorts from commodity fluctuations, though it doesn't remove the impact that such price changes can have. The push this pair has made into natural gas in recent years includes Exxon's purchase of XTO and Shell's acquisition of East Resources. When natural gas prices move higher, the negative of owning such gas assets will turn into a positive.

Exxon is rightly considered a core energy holding. It is appropriate for conservative investors. Royal Dutch Shell, meanwhile, is located in a financially weak region and doesn't enjoy the same market opinion of its shares. Indeed, Exxon's dividend yield is around 2.5% and Shell's is over 5%. Shell's risk profile probably isn't as high as the dividend discrepancy suggests, however, making the stock appropriate for even moderately conservative investors.

Coal

The future of coal and natural gas are currently entwined in an unusual way. With electric utilities increasingly using cheap natural gas, coal companies have seen demand and prices fall. Add the negative public view of coal, and there's a good reason to hate the energy source as an investment. However, as natural gas prices rise, coal demand will likely increase as utilities switch back to using this reliable and low cost base load energy source.

Note, too, that while coal use is falling in The United States, countries like China and India keep right on using it. It is also a key input for making steel. So, while the price of natural gas is important to coal demand, there are other factors that could change the negative view of coal investments. Two solid options in the space are Alliance Natural Resources (NASDAQ: ARLP) and Natural Resource Partners (NYSE: NRP). Both companies are limited partnerships and pay relatively large distributions.

Alliance is the largest coal focused LP and owns and operates its mines. It is well respected in the industry and on Wall Street, particularly since it has been able to increase its dividend regularly regardless of the coal market or the economy. With a recent yield of over 7%, this would be a good option for less aggressive investors.

Natural Resource Partners owns mines, but does not operate them. This means the company doesn't have to deal with the regulatory and safety risks of running a mine. While that materially simplifies the business, the company is reliant on its lessees' performance. Conservatively written contracts help to mitigate that risk to some degree, but it will always be an issue. A move to own and lease out properties with different resources, such as natural gas, is also a nice diversification effort. Still, the company's yield is close to 10%, which makes it appropriate for only the most aggressive accounts.

Unloved but Important

While natural gas and coal are both unloved in the commodity markets today, they are vital energy sources. Just how important the two are was highlighted by Exxon Mobil in its 2011 annual review: “Demand for natural gas is expected to rise by more than 60 percent by 2040, overtaking coal as the second most widely used fuel.”

While it is hard to predict when the prices of these “tied at the hip” commodities will rise, when they do, the above companies are likely to benefit. And having exposure to the number two and three energy sources isn't such a bad idea, either.


Reuben Brewer has a position in Natural Resource Partners. The Motley Fool recommends Alliance Resource Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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