A Bull Market Driven by Demand
In a year when oil prices rose 40 percent and natural gas surged 90 percent, it would have been exceedingly difficult not to make money in natural resources last year. And it was. The Lipper Natural Resources fund index gained 46 percent compared with just 4.9 percent for the S&P 500 index, making it the third year in a row that the index gained 25 percent or more. There's every indication that the good times aren't about to end.
"We are in the early innings of a natural resources bull market that will last this decade," says Andy Pilara, portfolio manager of the $1.7 billion RS Global Natural Resources Fund, which gained 42.2 percent last year. "When we look back on it, we will have been witness to something we have not seen before in history."
Emerging. By that, Pilara doesn't just mean a great bull run for natural resource stocks. He also refers to the historic event underpinning this sector's strength: the movement of a billion or more people in China and India toward a middle-class, consumer lifestyle. That shift means resources are being gobbled up like never before with demand driving prices higher. Take a commodity like zinc, used for galvanizing steel to prevent corrosion. China's move from a net exporter to a net importer of the metal has helped prices soar. One of Pilara's largest holdings is Teck Cominco, a zinc producer based in Canada. As for gold, up nearly 20 percent in 2005, Pilara eschews its role as a proxy for inflation and searches for "the lowest-cost producers," he says, citing Vancouver-based GoldCorp as a pick.
Demand from China is also a factor behind higher oil prices. But don't expect oil to have another year like 2005. Pilara is looking for oil and natural gas prices to "declinesignificantly" come spring as consumers conserve and demand eases. Fund comanager MacKenzie Davis says he focuses on companies that can make money on $45-a-barrel oil, not $60 or more. Among the fund's oil holdings are Exxon Mobil and offshore driller Noble Corp. And don't forget about coal, where demand exceeds current production in the United States. What's more, U.S. power generators plan to increase coal capacity by 25 percent over the next decade. Peabody Energy and Arch Coal are two fund favorites. Both focus on low-cost, low-sulfur coal.
Sure, there are risks to the bullish outlook, such as a big slowdown in China or here at home. When you're investing in natural resource companies, "what you're really doing is making a call on the durability and sustainability of the current global expansion," says Jack Caffrey, equity strategist at JPMorgan Private Bank. There are no guarantees. But Pilara will take that chance. "I think the opportunities far outweigh the risks," Pilara says. "I'm not losing too much sleep."
This story appears in the January 16, 2006 print edition of U.S. News & World Report.