Notice - Minyanville

Investing in commodities generally means holding either the actual physical natural resources (generally gold or another precious metal) or holding futures contracts that are linked to the commodity. But there is another option for tapping in to this asset class that takes an indirect route to commodities; stocks of companies whose operations revolve around the exploration, extraction, and sale of commodities. For example, stocks of gold mining firms can be seen as an indirect investment in gold.

These companies tend to exhibit relatively strong correlations to the underlying resources. That's because the profitability of these companies generally depends on the market price for the goods they sell. In the case of a gold miner, higher gold prices will generally translate into higher earnings since they will receive more money for each ounce of the metal they uncover and sell. Similarly, oil stocks tend to perform well when crude prices climb and timber stocks do well when lumber prices are elevated. The benefit of this approach is that stocks don't exhibit the contango that is common in commodity futures contracts ? often to the detriment of positions in these securities.

The above chart shows the stock price of Devon Energy (DVN), a popular natural gas producer, and the futures-based United States Natural Gas (UNG). The difference in returns is readily noticeable as Devon was able to vastly outperform US Natural Gas despite the massive decline in natural gas prices over this time period.

It should be noted that stocks of commodity-intensive companies will not always exhibit perfect correlation with the underlying natural resource. These stocks are, after all, stocks ? meaning that they will be impacted by movements in broad global equity markets. That may diminish one of the appealing attributes of commodities; the potential for diversification benefits and a low correlation with stocks and bonds.

Bottom Line: Equity invests can offer a unique spin on commodity investing.

This article is part of the series "Tips for Investing in Commodities." See also:

Tip 1: Futures Do Not Equal Spot

Tip 2: Commodities and Dividends Can Align

Tip 3: Watch Your Tax Rates

Tip 4: China Can Make or Break You

Tip 5: Low Inventories Can Lead to Backwardation

Tip 6: Diversification Is Not a Given

Tip 7: Rolling Front Month Futures Is a Recipe for Disaster

Tip 8: More Than Just Energy and Gold

Tip 9: Watch Out for That K-1!

Tip 10: Consider Expenses Always

Follow us on Twitter @CommodityHQ!

Editor's note: This article by Jared Cummans was originally published on Commodity HQ.

This entry was posted on Tuesday, June 5th, 2012 at 10:00 am and is filed under MV News. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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