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by Ben Power | 11 Sep 2013

In Australia over the past decade, most commodities have boomed on the back of demand from China and India, but in recent years prices have slumped. The ASX/S&P200 Resource Index, for example, has now fallen 36 per cent since it peaked in 2011.

This boom and bust cycle highlights the huge rewards on offer in resources and energy investments, but also highlights the risks. As retirees age they have less time to ride out boom and bust cycles, so few can withstand the risk.

“If you invest in resources and energy at the wrong time you can lose a lot of capital,” says David Lennox, resources analyst at Fat Prophets, adding that if you do invest at the right time you could gain a windfall. “That’s the risk in the game. But in the meantime you get little dividend.

“There’s not a lot of benefit in investing across the broader resources sector. It doesn’t pay a very good dividend and it is potentially high risk.”

How to invest

The hard work of those retirees determined to chase the rewards may pay off if they take a narrower view, judging individual resource and energy companies on their own merits.

Resources and energy investments are divided into roughly four areas or sectors:

  • Industrials: copper, nickel, lead and zinc
  • Bulks: coal and iron ore
  • Precious metals: gold and silver
  • Energy: natural gas and crude oil.

Traditionally, resources and energy have tended to rise as inflation has gone up, providing a hedge against higher prices of goods and services; they have also provided exposure to economic growth, because as economies expand they consume more raw materials and energy.  There are a number of ways to invest in these sectors, including stocks. The major miners such as BHP Billiton and Rio Tinto dominate and make up more than half of the S&P/ASX Resources Index. There is a raft of speculative smaller mining and resources companies, including 137 oil and gas stocks now listed on the ASX.  But investors don’t have to pick stocks; they can diversify through listed investment companies (LICs) that have stakes in a range of resource companies.  Exchange traded funds (ETFs), which track an index’s price and performance, have also gained in popularity.

Retirees can also invest in specific commodities, such as gold and silver, using a range of investment tools that track prices, including commodity specific ETFs. Derivatives such as warrants, CFDs and futures also track commodity prices, but most experts warn retirees off using those potentially risky leveraged instruments.

Despite all these options, Lennox says retirees should be wary of taking a broad punt on the energy and resources sectors.  The major downside is volatility. “The capital price can move significantly and usually in the short term, which is what retirees have to consider,” Lennox says.

But should you?

This year has been hard on the resources and energy sectors, and the stocks that operate in them. Big miners such as Rio Tinto and BHP have fallen 22 and 15 per cent respectively this year.

“The market has been very, very harsh on resource companies,” Lennox says. “The price of the commodity that most of them are digging up and selling has fallen sharply in 2013.”

Gold is another classic example of resources volatility; after surging to records as investors sought a safe haven, the gold price has dropped 25 per cent in the past year.

While the outlook for energy demand is still solid, energy stocks remain particularly risky for retirees because they have a structural disadvantage – they are price takers.  “They have to take the price given to them by the market,” Lennox explains. “All any resource company can do is ensure cost of production is as low as it can possibly be.”

By contrast, the major Australian banks, a favoured investment for retirees, have pricing power that allows them to maintain strong profits and dividends even in difficult economic times.

Still, energy and resources might pay off for those willing to work hard and carefully pick stocks.

“You can find good resource companies if you’re willing to sit down and work your way through individual companies,” Lennox says.  “But it’s very difficult to buy the sector and say, it’s going up or down. You have to look at individual companies, and that includes BHP and Rio.”

Strachan says retirees, if they do choose to invest in resources and energy, should stick to larger stocks like BHP, Woodside and Santos. “Leave the speculative stocks to others”