Frederick G. Fromm, CFA¹
Vice President, Portfolio Manager and Senior Security Analyst
Franklin Global Advisors

Year-to-date, we have seen significant increases in both the stock market and the price of oil. Our focus during this time has been on energy opportunities, given the depth of the sector's downturn and the supply correction mechanism. We have also broadened our focus to include opportunities in the diversified mining and gold and precious metals sectors.

Mining stocks have become more attractive as global economies continue to rebound from widespread recession and the credit crisis. In particular, China's robust economic recovery surprised many investors. Aggressive Chinese stimulus and infrastructure plans have led to a rise in metals imports, creating the appearance of a tightening of the supply and demand balance for many metals. In diversified metals, we are primarily focused on larger, more established companies. In the gold sector, we are taking advantage of robust commodities prices by targeting several smaller companies that appear to have strong development pipelines and may be seen as potential acquisition targets.

Overall, we have grown more cautious given how quickly natural resources have bounced back and how rapidly commodity prices and equity valuations have risen. There is some question as to whether the natural resources recovery has been driven by inventory building, which could subside; however, fundamentals appear to be improving for most commodities. We believe this should continue to be the case if global economies are able to achieve a sustainable recovery, which seems more likely than not at this point.

On a different note, we are closely monitoring the deliberations in the U.S. Senate on the "cap-and-trade" climate change bill, officially the Waxman-Markey bill. Cap and trade is a means to control industrial pollution by employing economic incentives and allowances. The consequences of a cap-and-trade system vary, depending on the sector, but most experts agree that industries producing greater levels of emissions will feel its brunt.

Coal producers, for instance, could be impacted if utilities are increasingly required to spend more on carbon-capture technology, which, in turn, may raise the cost of producing electricity from coal.

Likewise, oil refineries are at risk given the emissions released in the distillation process when gasoline and diesel are manufactured, not to mention when these fuels are consumed. Conversely, natural gas producers may benefit if utilities and some modes of transportation consume greater quantities of natural gas, which burns cleaner than liquid fuels or coal. This could tighten the supply and demand balance, which ultimately may drive up natural gas prices.

If the Waxman-Markey bill is passed, the potential ramifications are not known at this time. One broad-reaching implication may be the phasing out of the emissions-heavy U.S. refining industry. This could make the U.S. economy less competitive globally and could lead the U.S. to import more fuel and produce less locally. This possible scenario may also eliminate industry-related jobs and have other as yet unknown implications.

Please click here for more information on the FTIF - Franklin Natural Resources Fund.

Footnote
¹ CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.