Precious metals have been used as a store of value from time immemorial. Today, the average retail investor is able to trade in a wide range of precious metals through exchange traded funds with a simple click of the mouse.
Precious metals are valuable because of their scarcity. They also have crossover appeal since metals don’t just serve a single purpose. Precious metals are used in a wide range of applications, including coinage, jewelry, medical devices and electronics.
When we think of precious metals, gold immediately pops up. But a precious metals investor may move beyond gold assets and look into other metals when determining the best exposure for one’s investment portfolio.
Gold
Nevertheless, we shouldn’t completely ignore gold. Gold, besides being a good store of value, is a critical component in the electronics industry, especially in high-end technological equipment. The metal is in high demand because it is corrosion-resistant, highly conductive, chemically stable and serves as a heat shield.
More commonly, gold is used in jewelry and serves as a store of wealth or a substitute for currencies. The precious metal is also used as a good portfolio diversifier since it shows a low correlation to other classes, and it will generally move in the opposite direction of the U.S. dollar – gold is priced in U.S. dollars. [Tom Lydon Talks Gold on CNBC.]
Gold prices are less affected by the supply from gold miners because the huge above-ground stores of gold outweigh the supply of any new mine discoveries. It is this very reason that global central banks provide a very heavy hand on price fluctuations.
Growth and inflation in the emerging markets have boosted demand for gold. Emerging market central banks have more than doubled their purchases in gold bullion in the first half 2011 compared to the whole of 2010, which goes to show that central banks are betting that gold prices are here to stay. Central bank year-to-date net purchases are 203.5 tons, or a 168% surge from 76 tons for all of 2010.
In the recent market volatility, investors adhered to the age-old tradition of the flight to quality as economic red flags crop up. Any perceived threat to the stability of the financial sector, foreign exchange market or the government will push investors to gold as the go-to safe store of value.
Additionally, the record low interest rates and loose monetary policies enacted by global governments have helped stoke the flames of inflation, more notably in the emerging markets. As inflation eats away at the purchasing strength of individuals, investors will flock to gold for maintaining value.
Silver
Silver, like gold, has been used as a store of value – it is often referred to as the “poor man’s gold” – and a staple in fine jewelry, but this precious metal has a greater role in the industrial sector. As such, silver prices may be more volatile and more closely linked to industrial growth.
Silver is a main ingredient for several industrial applications, over half of silver is used for such purposes. It is the best electrical and thermal conductor — the metal is perfect for high-performance electronics or high-voltage circuits. The metal is even a natural biocide, which is handy in sterilization and treating wounds. Silver’s high reflectivity also makes it a must for fine-precision optics, and photosensitive silver compounds are the engine behind photographic film, or at least the demand used to be there before digital cameras took over. The growing middle class, more notably in the emerging markets, have also created a surge in demand for electrical devices, medical products and other items that require silver components.
Furthermore, demand for silver is expected to jump as the metal is used more in green technologies. For instance, photovoltaic cells in solar energy, water purification plants and silver-zinc batteries are heavily dependent on silver. [Why Silver ETFs Have Lagged Gold Prices.]
Platinum/Palladium
Platinum has recently touched upon parity with gold prices, hovering around $1,750 an ounce, and the closely related palladium has dropped to close to $740. Historically, platinum has fetched a higher price because it is much rarer and the sources are much lower compared to gold. [Gold ETFs Add 3% as Metal Touches $1,800 an Ounce.]
However, the recent rundown may be attributed to its industrial application. More than half of platinum and palladium goes into catalytic engines for the automobile industry, and any indication of slowing growth would have an immediate effect on the prices for these metals. Still, as emerging markets like India and China continue to grow, along with a burgeoning middle class, demand for autos should help bolster platinum and palladium prices.
Additionally, platinum and palladium are used in dental and medical applications, electronics and jewelry.
Currently, investors may gain exposure to the two metals through exchange traded products such as ETFS Physical Palladium Shares (NYSEArca: PALL) and ETFS Physical Platinum Shares (NYSEArca: PPLT).
Rare Earth Metals
Rare earth metals, like their moniker implies, are relatively rare compared to precious metals and are highly prized. They are also difficult to extract and process due to geographic and environmental challenges.
As our technological prowess progresses, rare earth metals are becoming increasingly vital for technological developments and the electronic industry. For instance, rare earth metals we may never have heard of before, such as lanthanum, cerium, praseodymium and neodymium, are used as crucial elements in common electronic devices like computers, memory chips, smartphones, flat-panel TVs and cameras. Additionally, rare earths also have military and defense technologies.
Investors have quickly taken to Market Vectors Rare Earth and Strategic Metals (NYSEArca: REMX). The fund holds a number of companies engaged in mining, refining and manufacturing of rare earth/strategic metals. REMX is currently the only broad rare-earth metals focused fund. [Is Uranium ETF a Bargain Buy Now?]
Investors may also take a look at the lithium fund Global X Lithium ETF (NYSEArca: LIT) as a way to cover the lithium market. Lithium is mainly used in the industrial sector, and as such, prices will follow industrial growth.
The Various Types of Commodity ETFs:
Equities. Equity-based metal ETFs are funds that hold mining companies and other companies involved in the production of various metals, such as Global X Copper Miners ETF (NYSEArca: COPX), Global X Silver Miners ETF (NSYEArca: SIL) and Market Vectors TR Gold Miners (NYSEArca: GDX). The performance of these companies is not always correlated to their underlying commodity, but when prices of their commodities are high, profit margins generally improve. For some of the more uncommon metals, such as lithium, equity-based commodity ETFs may be the only way to gain exposure to these commodities in an ETF. [Gold Miner ETFs Rally Back Near Lifetime Highs.]
Physical. Physical ETFs hold the actual physical commodity, which is stored in the vaults of London, Switzerland and now Singapore, and owners of the ETF own an interest in a fractional amount of the underlying metal. The small retail investor may consider physical ETFs over holding the physical commodity because of costs associated with storage of the commodity. More physically-backed metals funds have made an appearance in recent years, including the popular SPDR Gold Shares (NYSEArca: GLD) and iShares Silver Trust (NYSEArca: SLV).
Futures-based. Most metals, as are most commodities, are traded on futures exchanges. A future is a promise to buy, or sell, a commodity for a set price at a set date in the near future. A majority of the future contracts traded on the exchange floor are settled or swapped for cash before the expiration date. Before ETFs came into existence, futures generally weren’t accessible for small investors. Examples the PowerShares DB Silver (NYSEArca: DBS) holds silver futures contracts, which may be subject to the damaging effects of contango.
Demand for metals is on the rise, and investors are showing a growing interest in precious metals ETFs as an easy way to gain exposure to precious metals price movements. Whatever precious metal piques your fancy, be sure to read up on how the fund works so that there are no nasty surprises down the line.