Commodities

You May Not Be as Diversified as You Think

05/02/08 - 07:09 AM EDT


Every portfolio, no matter how well it is constructed, is vulnerable to something.

Investors who rely on actively managed funds or broad-based index funds often end up too heavy in the financial sector; those who go with individual stocks and sector funds face a similar threat if too many of their holdings correlate too closely.

One less-obvious example of this problem is with emerging-market stocks and mining stocks. Both segments have been terrific sources of outperformance for several years, and there is a compelling fundamental argument in the growth rates and increased demand to tell us that both segments should continue to do well over the long term.

As this chart of iShares S&P Global Materials Index FundMXI and BLDRS Emerging Market 50 ADR Index FundADRE shows, the correlation between the two has been very tight, including during several big and fast corrections.

Click here for larger image.

The connection is quite logical. Growth and modernization in places such as China and India have been big catalysts for increased demand for natural resources. This benefits the countries that are experiencing the demand, as well as those countries capable of supplying the commodities -- many of which are emerging markets such as Brazil and Chile.

This infrastructure buildout has many more years and several hundred billion dollars to go. China needs iron ore and copper, and so will other countries such as Pakistan and Vietnam as they follow the same path, creating long-term visibility for these trends.

None of that isolates these stocks from nasty declines every now and then.

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At the time of publication, Nusbaum was long MXI and ADRE on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.


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