Diversify your 401(k) with these cheap investments that nobody else wants right now

By Brett Arends

It's rescued investors in the past from a lost decade

If you want to add some diversification to your 401(k), IRA or other retirement portfolio, take a look right now at natural-resource stocks.

That means stocks of oil and gas producers, and those that mine and refine key metals and other elements for industry.

Not only are they powerful portfolio diversifiers, covering your risks in a bear market, but they are reasonably valued at the moment and - best of all - all the big money institutional investors have sold out of them, so they are sitting, unwanted in the bargain bin.

If you own a plain stock-market index fund, such as the SPDR S&P 500 SPY ETF, less than 6% of your money is invested in these companies. And that may be a missed opportunity, because natural-resource stocks are the only ones that have persistently provided real diversification benefits.

That's been true at least since the early 1970s. Over that time, natural resource stocks have been negatively correlated with the rest of the stock market over a typical 10-year period. They've zigged when the rest of the market has zagged.

That was true in the 1970s, in the 2000s, and as recently as 2022. If you held a plain-vanilla equity fund or portfolio, you got hosed. If you held some money in resource stocks, you were much better off.

The 1970s were a lost decade for U.S. stock investors, but not for investors in energy and mining stocks. Ditto the 2000s. From 2001 through 2010, the S&P 500 SPX earned you just 17% in total, including reinvested dividends.

U.S. energy and mining stocks during the same period: 220%, according to FactSet.

GMO, the white-shoe fund company in Boston, recently published research that shows that since 1973 natural-resource stocks have been the only stock-market sector negatively correlated with the rest of the market.

"Not only are raw materials finite - believe it or not! - getting scarcer, and therefore certain to rise in price, but at longer horizons (10 years) resources are the only sector of the stock market to be negatively correlated with the broad stock market," writes Jeremy Grantham, GMO's famous co-founder and now its long-term investment strategist.

"They are far and away the most diversifying sector," he concludes, adding: "They are also particularly cheap today having been whacked recently."

GMO's analysis, available here, shows that resource stocks have been a powerful diversifier even over three-year periods. You didn't have to wait a decade to reap the rewards.

Meanwhile, BofA Securities reported this week that the world's biggest institutional investors have slashed their exposure both to natural resource stocks and the commodities they produce. Their allocation to commodities is down to its lowest level since June 2017, BofA Securities reports. Their allocation to energy stocks is down to its lowest level since late 2020, and their allocation to other natural resource stocks is at its lowest level since June of that year.

Money managers are worried about slowing demand in China, as well as a potential recession in the U.S. And as these are the least "green" industries in the world, a growing number of endowments and institutional investors are dropping them from their portfolios as a matter of principle.

But all of this, as long-term readers know, is inherently bullish. You can't get a bargain if it's a seller's market. Right now it seems to be a buyer's market.

Naturally, there are caveats. Over the long term, most commodities have fallen in price as societies have become more efficient. And global warming is real. That's ultimately news for the producers of fossil fuels.

And while resource stocks may be inexpensive relative to the rest of the stock market, that may be only because the rest of the stock market is expensive.

But even if the oil and gas industries are on the way out, for environmental reasons, that need not be disastrous for investors. When an industry stops growing, competition dies out. Few new companies come on the scene. And the existing players stop spending so much money on "growth," and start just banking the checks as they come in. Tobacco has been on the way out for two generations - I don't even know anyone who smokes anymore. But tobacco stocks have produced staggeringly high returns at the same time. Over the past 20 years, the FactSet index of global tobacco stocks has produced over 900% returns - or nearly twice those of the broader global stock-market index.

The simplest one-stop ETF for this sector is the SPDR S&P Global Natural Resources ETF GNR, which has been around since 2010, charges 0.4% a year, and has $3.2 billion under management. There's a North America-only equivalent, the SPDR S&P North American Natural Resources ETF NANR, but you miss out on all the extra diversification of a global portfolio without saving much on the fees.

For those who only want energy stocks, there are plenty of options. Fidelity MSCI Energy Index FENY charges 0.08%, State Street's Energy Select Sector XLE 0.9%, and Vanguard Energy VDE 0.1%. All invest in U.S. energy stocks. The iShares Global Energy ETF IXC, which invests globally, charges 0.41%. U.S. energy stocks make up about 60% of the portfolio.

Investing in the underlying commodities themselves is a very different prospect. People managing these funds have to use financial derivatives to give you exposure to the prices of oil, copper, steel and so on. That raises all sorts of complications - and costs. (The main exceptions to this are precious metals funds, but that's another story). Commodity ETFs raise possible tax issues as well. I'd only own one in a sheltered account like a 401(k) or an IRA, if that. But for an easy life and low stress, I'd much rather own the natural-resource stocks.

-Brett Arends

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09-21-24 0813ET

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