Sunday, February 11

Week 345 - Natural Resource Companies in the Vanguard High Dividend Yield ETF

Situation: All natural resource companies have been affected by the 2014-2016 commodities crash. That event was largely driven by the rapid upgrade in commodities production and transportation that was needed to meet demand in China. That supply chain collapsed with the rapid defervescence in Chinese demand, and has only now returned to being in balance worldwide. 

You have to look to the dominant commodity (oil) to understand why the crash was so sudden and deep. Just as Chinese demand was tapering off, new production (from unconventional sources like oil sands and shale) was coming online in North America. Those expensive projects had seemed worthwhile in a world where a barrel of oil was often worth over $100. Oil prices then collapsed when increased production met falling demand. The largest producer (Saudi Arabia) normally would have cut production to keep prices high. But this time the Saudis chose to increase production, hoping to force shale drillers in the United States to give up their costly projects. It didn’t work. American drillers adopted new technology (e.g. horizontal drilling), cut costs, and borrowed heavily to stay in business (even though the price of oil fell to $30/bbl).

Mission: Survey the damage done to strong commodity producers, equipment suppliers, and railroads (which often invest in their main shippers). Stick to companies listed in the US version of the FTSE High Dividend Yield Index, i.e., those in VYM (Vanguard High Dividend Yield ETF).

Execution: see Table.

Administration: We find only 3 Natural Resource-related companies in the Extended Version of “The 2 and 8 Club” (see Week 329): Caterpillar (CAT), Occidental Petroleum (OXY), and Archer Daniels Midland (ADM). We have added 3 more that are in the Vanguard High Dividend Yield Index (VYM) and meet all other requirements for membership in “The 2 and 8 Club” except the requirement that dividend growth be 8%/yr (see Column H in the Table): Norfolk Southern (NSC), Deere (DE), and Exxon Mobil (XOM).

Bottom Line: No matter how you choose to invest in commodities, you’ll be buying into a high-risk asset. You need to monitor positions daily, and have cash available to fund margin calls and attractive developments. Column D summarizes the risks you’ll face (see Table): Even the best companies lose a lot of capital in a commodities crash. And the crash always starts suddenly and goes to unanticipated extremes, leaving all players affected.

Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into XOM and own shares of CAT.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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