Investments

What Are Materials

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 11 minute read

Many people don’t give the basic-materials industry the attention it deserves. Investments in areas like tech, services, and health care are likely to be on your mind if you’re like most people. 

Many investors, however, pay little attention to the businesses that mine the metals used in memory chips, supply the textiles for airplane seats, or manufacture the chemicals used in the world’s most effective medications.

You can be sure that at least one primary material was used in the creation of anything you purchase. Plastic and metal are utilized to make phones and computers that enable telemarketers to do their jobs.

For this reason, it’s hardly surprising that the basic-materials industry is highly lucrative. Certain businesses in this industry generate enormous profits thanks to the global demand for their indispensable products.

It stands to reason that financiers would like a piece of the action in the global market for producing and selling basic resources due to the profits that can be made from doing so. But before you invest in basic-materials stocks, you should learn about the sector and what drives companies in it.

What Are Stocks in Basic Materials?

Companies whose stocks trade under the basic-materials ticker symbol operate in that industry. So, what exactly are the raw materials? Most things can be reduced to their basic materials. Metals, concrete, plastics, and even jewelry all begin with these elements. 

Commonly used staples include the following:

  • Valuable Metals. Precious metals come in many forms, including gold, silver, and platinum. As a result of their scarcity and mining costs, these metals command a high price. Therefore, they are frequently employed in the creation of jewelry.
  • Oil. Oil is the foundation upon which the energy industry is built. There is a broad variety of fuels and products that can be made from refining oil, but some of the most common are gasoline, diesel fuel, and jet fuel.
  • Wood. Likewise, wood is a fundamental material because it was used to construct your house, your kitchen table, and the structure of your couch.
  • The Mineral Used to Make Iron. Iron ore is a crucial raw ingredient in the manufacturing of steel, which goes on to be utilized in everything from the eye-catching skyscrapers of the metropolis to the mechanical parts of your car’s engine.
  • In their unprocessed form, raw chemicals are. Products like medicines and cleaning solvents can’t be made without the raw chemicals that go into their creation.

Many of the most fundamental components of life can be found in nature. Some chemicals used in medicines, perfumes, and cleaning supplies are, nonetheless, products of human ingenuity. 

A material’s status as one of the most fundamental, raw components present in commonplace items is what distinguishes it, regardless of whether it is synthetic or natural.

There are a variety of methods that basic materials, including natural ones, can be manufactured. Certain ones may be recycled or replenished, giving businesses an endless supply to make, use, and sell. One such sustainable raw material is wood.

Nonetheless, there is a limited supply of some elemental substances. It takes a very long time, even millions of years, for these minerals to form. Oil, precious metals, stone, and other construction materials are all examples of the finite basic materials that make up the bulk of the basic-materials market.

Does It Sell Basic Materials?

Newcomers typically feel lost in the basic-materials industry. For example, it might be difficult to determine whether or not a stock is in the basic materials sector or another.

A company is not always a basic-materials company just because it uses a basic material. Be aware that basic-materials firms focus on exploration, new product development, and primary processing of raw materials.

The gold mining firm fits the profile of a basic materials producer. A basic-materials firm, it processes the gold to make uniform, standardized, and portable bars. A basic-materials company would not include the jeweler who makes a necklace out of the gold or the dentist who places the gold in a patient’s teeth.

Companies that produce fundamental materials and those that use them will be valued differently, run their businesses in distinct ways, and react to market fluctuations in distinctive ways.

The Advantages and Disadvantages of Basic-Materials Stocks

You should weigh the benefits and risks of every investment carefully before making a final decision. There are advantages and disadvantages to investing in basic-materials equities, just as there are to investing in anything else. The following are some of the advantages and disadvantages of entering the market.

Advantages of Stocks in Basic Materials

All the things on the store shelves have the same basic components. Consequently, it stands to reason that there will be rewards for those who make investments in the sector. The advantages of investing in the basic-materials sector are numerous and significant.

1. Basic Materials Will Always Be in Demand

Anything you see around you—from the car you drive to the house you sleep into the bed you sleep on to the clothes you wear—was likely made using a variety of different types of basic materials. What an enormous claim to make.

Wood, iron ore, and oil are necessary for life as we know it. Strategically, it makes a lot of sense to put money into businesses that provide something everyone needs on a regular basis. This is what draws investors to basic-materials companies and what makes consumer staples firms so appealing.

In the end, investing in goods necessary for daily life in industrialized nations provides a sense of stability that even the most remarkable tech equities can’t equal. Even if Apple’s iPhone is killing it in sales right now, tomorrow’s hot new phone could make the iPhone obsolete. 

Timber and steel, on the other hand, will always be in demand for construction purposes. It follows that these goods will remain relevant indefinitely.

2. Some Stocks of Basic Materials Are Cyclical

Stocks in certain sectors related to basic commodities tend to go up and down with market cycles. Stocks in the cyclical sector rise and fall in tandem with the economy. For this reason, these stocks usually see upward price movements during times of good economic health. These stocks, on the other hand, lose money when economic conditions are poor.

Many equities in the basic-materials industry are easy to time due to their cyclical nature. If you watch the evening news, you can get a sense of the economy. Market participants should buy when conditions are favorable and sell when they are unfavorable. 

A person’s ability to produce profits and possibly outperform the market is increased when they can use economic conditions to guide their investment decisions.

Investment opportunities in basic minerals that are subject to cycles include, for instance:

  • Manufacturers of Wood Products. Companies in the forestry industry that make money from the sale of wood have ups and downs when the economy fluctuates, as consumers are more inclined to construct when they have faith in the economy’s predictability and their capacity to repay mortgages and other construction loans. Therefore, forestry stocks tend to rise in a healthy economy. In contrast, forestry businesses frequently tank during economic downturns.
  • Energy Giants. Consumers cut back on going out to restaurants, movies, and other public activities when the economy is bad. As a result, fewer fossil fuels are used. A further effect on the oil market could come from consumers’ increased focus on domestic energy use. Conversely, when the economy is doing well, people tend to take more trips and be more liberal with their energy usage, both of which contribute to rising demand for oil and thus, higher oil prices and stock prices.
  • Alternate Construction Supplies. Production of construction materials like iron ore, steel, glass, and copper tends to follow economic trends because of the cyclical nature of the construction and real estate markets.

3. Many Basic-Materials Stocks Serve As Safe Havens

Although certain equities in the basic materials sector are more cyclical, others are considered safe havens. That’s because investors tend to pour money into these equities when they anticipate a general market downturn due to unfavorable economic conditions. 

When economic conditions improve, however, investors often sell off their safe haven holdings, which can lead to price falls. A gold miner is the quintessential example of a stable basic-materials enterprise. Gold and silver are often preferred investments during times of economic and financial instability because of their perceived safety and stability. 

Therefore, precious metals appreciate as the economy falters. For the businesses that specialize in mining these metals, that’s fantastic news. When things are tight, the price of gasoline goes down, which means cheaper mining. 

Likewise, as demand for safe-haven investments rises, these businesses are able to charge higher prices for their final products. This means improved profitability, lower costs, and a higher stock price for the company.

Having some investment options that are relatively secure can be comforting during times of economic uncertainty.

Disadvantages with Basic-Materials Stocks

The advantages of basic-materials stocks are considerable; nonetheless, even the most excellent products have their flaws. Stocks in fundamental materials are no exception. Before committing capital to the basic-materials industry, think about the following potential risks.

1. Circularity Is Not Always Good

Stocks in the basic-materials category are overwhelmingly cyclical. Though this is fantastic news for some shareholders, cyclical equities aren’t for everyone.

Finally, if you want stocks that develop slowly but steadily and have the potential to pay dividends, you won’t find anything to your liking in the basic-materials sector.

Your entry and exit timing are crucial, even if investing in cyclical companies makes it a little easier. Timing is less essential with slow-growth dividend bets because these stocks typically trade flat or suffer tiny gains or losses even during severe economic periods. 

However, investing poorly at the wrong moment can be devastatingly expensive due to the fact that cyclical stocks tend to plummet when times are rough economically.

2. This Industry Is Boring

If you’ve ever watched an episode of “Shark Tank,” you know that Lori Greiner, Daymond John, Mark Cuban, and Barbara Corcoran never put money into a product they can’t personally connect with. Only occasionally do Kevin O’Leary and Rober Herjavec.

Why don’t sharks put their money where their mouths are? Simply said, you need to study your investment carefully before putting any money into it. You’ll be less inclined to complete the research required to protect your investment returns if you put your money into a field you have no interest in learning more about.

The truth is that fundamental resources aren’t very exciting. Literally, boring could be a synonym for basic. Compared to sexier investments like Apple or Facebook, fewer investors take pleasure in the research required for these equities.

3. Big Businesses May Not Turn A Profit.

Developing raw resources through mining and other means is an extremely costly endeavor. For serious financial success, a space operation must be vast. For even the most established companies in the raw-materials market, this poses a profitability challenge.

Many companies dealing with basic commodities have market caps in the hundreds of millions or even the low billions of dollars yet nonetheless manage to turn a profit. The news is not good. Mining firms are dependent on the goodwill of lenders and investors due to the prohibitive nature of the industry.

Are Basic Materials Stocks a Good Investment?

To some, basic-materials stocks are a must-have, while to others, they aren’t even a viable option. 

The following are two essential traits for any investor in the basic-materials market:

  1. A Sincere Fascination With The Basics. To get the most out of your investments, you need to care about the subject. As a result, if you want to invest in basic-materials companies, you should have a general interest in learning about these resources and the industry that surrounds them.
  2. Adaptability In The Face of Changing Economic Circumstances. A large proportion of basic-materials equities tend to follow a cyclical pattern. In order to know when to buy and sell cyclical equities, investors must keep a watch on the overall economy.

How Much Should You Put Into Stocks of Basic Materials?

When building a portfolio, it’s not a smart idea to put all your eggs in one basket of stocks. The same holds true for supplies of basic materials. How therefore should one allocate resources while still maintaining a focus on diversification?

Consider the following questions when you weigh how much of your portfolio to allocate to basic-materials equities.

Are Things Good in the Economy?

The health of the American economy will affect the fortunes of nearly all basic materials stocks. Stocks of basic resources other than precious metals will generally fall as the economy worsens.

In times of economic expansion, these equities typically rise in price. But the converse is true for basic-materials firms that specialize in rare metals.

As a result, during times of economic upheaval, it is prudent to commit a larger portion of one’s investing capital to precious-metals enterprises. When economic conditions are favorable, however, a lesser portion of your investments should be made in this group.

When the economy is doing well, a bigger percentage of your portfolio can be allocated to stocks of companies that produce basic materials; when things are bad, a lesser percentage is preferable.

What Are Your Investment Objectives?

Investment allocation selections should always be made in light of your investment objectives. Stocks in the basic materials sector, for instance, may not be the best bet if you’re after substantial dividends and steady expansion. Consider the utility sector instead.

To capitalize on the cyclical nature of basic-materials companies and outperform the market, investors may consider making purchases at market lows and selling at market highs.

Observe the 5% Rule

For new investors, the 5% rule is one of the most crucial rules to follow. If you follow the guideline, you won’t put more than 5% of your portfolio into any one stock and won’t put more than 10% into a group of high-risk equities.

So, you can put up to 5% of your portfolio worth into a stock of a well-established basic materials company.

Say, for argument’s sake, you have $10,000 to put toward investments. Your confidence in the future growth of a basic-materials stock is low but not zero. Taking into account the 5% rule, you can put up to $500 into the stock, but you’re still on the fence about it. If you want to get some exposure while limiting your risk, you could invest $250, which is half of your maximum allocation.

Trading in high-risk equities is a bit different. You now have 5% of your portfolio as a whole to allocate to your riskier holdings, down from 5% for each individual stock. In light of this, let’s imagine you have a $10,000 portfolio and are considering investing in four high-risk equities. You’re aware of the potential downsides but nevertheless hope to gain access to these promising prospects.

The 5% rule suggests spreading $500 among four high-risk equities. If you’re contemplating four high-risk opportunities, you could invest $125 in each one if you split the whole $500 budget that way.

Bottom Line

Stocks in basic materials have many advantages. In the end, without them, our familiar world would no longer exist. The appropriate investors can find gains by purchasing these stocks, but they should first do their homework. Moreover, regardless of the industry that sparks your interest, diversification is essential.

However, success in the basic-materials sector is possible if you put in the time and effort to learn the industry, diversify your holdings, and make well-informed choices.

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