CHAPTER 5: NATURAL RESOURCES Flashcards
Natural resources include:
- Commodities
- Farmland
- Timberland
Commodities: Can be further classified into:
HARD & SOFT
HARD= MINED
SOFT= GROWN or FATTENED
- Hard: Commodities that are mined e.g., copper, gold, silver; and commodities that are extracted e.g., crude oil, natural gas.
- Soft: Commodities that are grown over a period of time e.g., grains, livestock, and cash crops like coffee.
FARMLAND
Investments in land used for the cultivation of crops or livestock.
Income can be generated from the growth, harvest and sale of crops or livestock; or by LEASING the land back to farmers.
TIMBERLAND
Investments in natural forests or managed tree plantations.
The return comes from the sale of trees, wood, and other timber products
HISTORICAL VS CURRENT INVESTMENT APPROACH
Historical Investment Approach:
Past Investment Method:
- Investors sought exposure to natural resources via financial instruments like stocks and bonds.
- Focus was on companies producing natural resources rather than the physical assets themselves.
Current Investment Approach:
Modern Direct Investment Options:
- Investors now have access to a variety of direct investment options.
- Instruments include ETFs, limited partnerships, REITs, swaps, and futures.
- These options allow investors to participate directly in natural resource assets.
Timberland Investment Overview:
Income Stream:
- Provides income through the sale of trees, wood, and other timber products.
Dual Function:
- Acts as both a factory and a warehouse.
Storage Flexibility:
- Trees can be stored by not harvesting them.
Price-Based Harvesting:
- Harvest more when prices are high.
- Delay harvest when prices are low.
The three return drivers for timberland investments include:
- biological growth
- change in prices of lumber (cut wood): unique to timberland
- underlying land price change.
Additionally, since trees consume carbon as part of their life cycle, timberland considered a sustainable investment that mitigates climate related risks.
TIMBERLAND VS FARMLAND
TIMBERLAND: longer life asset/product: don’t die: you can decide when to sell (usually when price is high)
FARMLAND: GROW crops or livestock: sell when ripe, or it’ll get spoilt or die: you can’t decide when to sell
Timberland gives you both YIELD & GROWTH, which is not the case with farmland.
Similar to timber land, the return drivers for farmland are:
- harvested quantities
- commodity prices, and
- land price appreciation.
Farmland is also considered a sustainable investment that mitigates climate-related risks.
Farmland Investment Overview:
Inflation Hedge:
- Perceived to provide a hedge against inflation.
Types of Farm Crops:
- Raw crops: planted and harvested seasonally.
- Permanent crops: grow on trees.
Income Component:
- Related to harvest quantities and agricultural commodity prices.
Production Flexibility:
- Unlike timberland, farmland lacks production flexibility.
- Farm products must be harvested when ripe.
Land Investments vs. Real Estate
Similarities & Differences
Similarities:
Nature of Assets:
- Unique, illiquid assets.
- Distinct geographic locations and features.
Differences:
Development Focus:
- Real Estate: Focus on physical development of the property.
- Land Investments: Quality of soil and climate are more critical.
Location Importance:
- Proximity to transportation hubs and markets increases value.
- Transportation expenses significantly impact the price of products from timberland and farmland.
value:volume ratio= onions & tomatoes take a lot of volume, but don’t have a lot of value (giffen goods). transportation as a % of value becomes a lot. therefore, proximity to hubs is important
TIMO
TIMBERLAND INVESTMENT MANAGEMENT ORGANIZATION
Land Investments vs. Real Estate
Investing Requirements:
Specialized Knowledge:
- Investors need expertise specific to natural resources.
- Example: Investing directly in timberland requires forest management expertise.
Institutional Investors:
- Often lack the necessary specialized knowledge.
- Rely on Timberland Investment Management Organizations (TIMOs).
- TIMOs use their expertise to analyze and acquire suitable timberland holdings for institutional investors.
RAW LAND
Return Drivers
Source of Direct Revenue
Value Factors
Main Risks
Owners
Ownership Structure
Return Drivers:
- Price of land
Source of Direct Revenue:
- Price appreciation
- Lease revenue
Value Factors:
- Physical location
Main Risks:
- Best alternative use
Owners:
- Mostly institutional, some individual
Ownership Structure:
- Direct ownership
- Partnership
FARMLAND
Return Drivers
Source of Direct Revenue
Value Factors
Main Risks
Owners
Ownership Structure
Return Drivers:
- Harvest quantities
- Commodity prices
- Price of land
Source of Direct Revenue:
- Sale of crops and other agricultural products
- Price appreciation
- Lease revenue
Value Factors:
- Physical location
- Soil quality
Main Risks:
- Weather factors and climate change
- Biological factors, diseases
Owners:
- Mostly individuals (since smaller), some institutional
Ownership Structure:
- Direct ownership
- Partnership
- REIT
Features and Forms of Farmland and Timberland Investments
TIMBERLAND:
Size:
- Typically thousands or more acres
Ownership:
- More commonly owned by institutions
Advantages:
- Larger scale investments
FARMLAND:
Size:
- Frequently owned in smaller tracts of tens or hundreds of acres
Ownership:
- More suited to family ownership
Advantages:
- Broader universe of agricultural product price exposures compared to futures contracts
- Ownership allows for cultivation of crops not traded on futures exchanges
TIMBERLAND
Return Drivers
Source of Direct Revenue
Value Factors
Main Risks
Owners
Ownership Structure
Return Drivers:
- Biological growth
- Harvest quantities
- Lumber prices
- Price of land
Source of Direct Revenue:
- Sale of trees, wood, and other timber products
- Price appreciation
- Lease revenue
Value Factors:
- Physical location
- Growth cycle
- Quality of timber
- Phase in timber production
Main Risks:
- Biological factors, diseases
Owners:
- Mostly institutional (since bigger), some individual
Ownership Structure:
- Direct ownership
- Partnership
- REIT
- TIMO (Timberland Inv Management Org)
Common Features between Farmland and Timberland Investments
Common Features:
Price Transparency:
- Limited price transparency or information to guide investment decisions
- Assistance from sector specialists required
Illiquidity:
- Direct investments are illiquid
Weather Sensitivity:
- Farmland is highly sensitive to weather changes, which can drastically reduce harvest yields
COMMODITIES
Commodities are physical products that can be standardized on quality, location, and delivery for investment purposes.
Which of the following is a common source of direct revenue from raw land, farmland and timberland investments?
A Lease revenue
B Sale of agricultural products
C Sale of trees and wood products
A is correct. Lease revenue and price appreciation are common sources of direct revenue from raw land, farmland and timberland investments.
B is also a source of direct revenue from farmland investments while C is another value driver applicable to timberland investments.
Which of the following types of investment is most suited to family ownership?
A Farmland
B Timberland
C Both A) and B)
A is correct. Farmland is more suited to family ownership, whereas timberland is more commonly owned by institutions.
This is because timberland tracts are typically thousands (or more) of acres in size, whereas farmland is frequently owned in smaller tracts of tens or hundreds of acres.
Which of the following is most likely an advantage of institutional ownership of physical farmland as opposed to buying exposure to crops through futures contracts?
A No requirement for sector specialists
B Exposure to broader universe of agricultural products
C Transparent pricing of farmland
B is correct. Futures contracts are only available on a few common crops (such as wheat and corn). Ownership of physical farmland allows for the cultivation of crops that are not traded on futures exchanges, resulting in a broader universe of agricultural product price exposures.
A and C are not correct because assistance from sector specialists is required due to limited price transparency or information to guide investment decisions.
