Materials: Investing Essentials

Here's what you need to know about investing in materials.

Aug 6, 2014 at 12:00AM

Materials Mining Equipment

Image source: BHP Billiton.

Look around you right now. Everything that you see got its origins somewhere in the materials industry. The building you're in, or the automobile you drive, all started as piles of minerals that needed to be extracted and processed into the products they are today. The job of turning those raw elements into the basic materials we use on an everyday basis is the materials industry, and there are loads of companies out there doing it.

For many, investing in materials is a pretty nice space. There are lots of barriers to entry, it can have geographical benefits, and you can rest assured that humans will always use these materials one way or another. Let's take a quick look at the materials industry to give you a better understanding of what it is, what drives it, and how you can invest in it.

What is the materials industry?

The materials industry is an extremely broad one, but the basic definition is any produced raw material other than oil and gas, and food. The materials industry is generally broken up into these subsectors, with a couple of examples within each sector below:

  • metals and mining (example: gold, iron and steel, copper)
  • chemicals (plastics, agricultural chemicals and fertilizers, industrial gases)
  • construction materials (cement, crushed rock)
  • forest and paper products (lumber, paper)
  • containers and packaging (glass and metal containers, cardboard)
Chemcial Manufacturing Plant

Chemical manufacturing plant (image source: Secl via commons.wikipedia.org)

Considering how many items are covered in this sector, it should come as no surprise that the entire industry is worth close to $5 trillion. The size of these companies can vary from those only worth a few million dollars that specialize in a particular type of package or a specialty chemical, all the way up to the large diversified mining giants that have market capitalizations in excess of $100 billion.

The reason that there's so much money tied up in this industry is because it is extremely capital intensive. The entire process of going from a source mine all the way to the manufacture of the final product requires loads of energy and manpower, and normally involves a global supply chain to make it happen. This is why you see such massive mining companies, because they are able to benefit from economy of scale, and are able to secure the financing to take on major mining projects.  

What is the history of the materials industry?

Humans have been using materials ever since we started building basic tools, such as stone-tipped spears, or using wood to make fires and homes. Probably the best jumping-off point to start at is the Industrial Revolution, because it's pretty close to the way that the materials industry works today.

During this time, we started to build methods to produce high-grade steel on a commercial scale, and developed some of the modern methods for creating cement. Ever since that time, we have been manufacturing these materials for the construction of infrastructure, automobiles, and equipment, or even to enhance the production of these materials. After the turn of the 20th century, the advent of plastics using certain chemicals found in oil and gas came along, and is now a major part of the materials sector.

One of the biggest changes in the materials sector over the years has been the globalization of the value chain. This isn't the case for all materials, such as crushed rock for concrete, but more valuable materials can go all over the place before being sold. For example, steel will start with iron ore from Australia, and alloys such as chromium and manganese from South Africa, which is all shipped to China for milling. Once fabricated, that steel is sold and shipped all over the world. The more precious the material, the greater chance it has a complex and more globalized supply chain.

How many ways are there to invest in materials?

Iron Ore Mine

Mining for iron ore (image source: University of Texas)

The simplest way to invest in materials is in the companies that deal directly with the material. That can be the mining companies that extract the raw materials, or the manufacturing companies that transform the raw material into a usable product, such as a chemical or steel manufacturer.

This industry is incredibly diverse because, not only is it traditionally the jumping-off point for so many other industries, it has its own supply chain that investors can target in particular ways, as well. For example, instead of investing directly in the mining companies that extract resources, you could invest in the equipment manufacturers that supply the miners with the tools to do their jobs. Or you could invest in the rail or shipping industry that transports the raw metal ores to the production facilities, or even the oil and gas industry that supplies the feedstocks to chemical manufacturers. 

Then again, there's the possibility that, instead of buying the companies responsible for these products, you could buy the products directly. The most common way this happens in the materials sector is through the purchase of gold; but just about every commodity is bought and sold on the open market through futures contracts.

What drives the materials industry?

There are loads of different products and companies that are covered in the materials industry, but they are all driven by one economic principle: the power of scarcity. The power of scarcity is the ability to provide a product at a price that others simply cannot. The easier it is to provide that product, the more companies are willing to get in on the action, and the more it becomes a buyer's market. Here are some examples of things that can make a product more scarce: if the product is bought and sold on a global or regional scale, what the product is used for, and where the centers of supply and demand are located. 

The entire industry is very cyclical as it goes through periods of scarcity and abundance based on those characteristics above. One of the more general trends that we can pretty much rely on, though, are population and economic growth. Since 1961, global population has grown 2.28 times, but consumption of almost all materials has grown at a much faster pace -- steel 4.26x, cement 11.1x, aluminium 9.45x, plastics 48.33x. These products are pretty much essential to growth and development, and will continue to be. So, as long as global economic health remains strong, it's likely that companies working in this field will be doing just fine.

You can follow Tyler Crowe at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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