After a volatile start to the year, precious metals exchange traded fund advisors will have to consider factors beyond market risks.
On the recent webcast, June Update: Central Bank Separation Anxiety, James Butterfill, Head of Research and Investment Strategy at ETF Securities, pointed out that world growth has stabilized, the likelihood of a global recession has diminished, and core CPI will likely continue to steadily rise.
Consequently, as growth improves and inflation rises, we are back to waiting for an eventual Federal Reserve interest rate hike, which may trigger market fears over policy mistakes and potential pressure growth.
For the precious metals market, traders will have to keep close tabs on the Fed as gold has been closely correlated to real interest rates. We have seen gold outperform in negative interest rate periods.
Furthermore, some precious metals are also affected by factors beyond investment demand. For instance, Butterfill pointed out that silver enjoys heavy industrial demand – about 56% of total demand for silver comes out of industrial fabrication, followed by jewellery 20%, coins & bars 18% and silverware 6%. Nevertheless, silver remains correlated to gold’s fortunes.
Platinum and palladium also enjoy heavy industrial demand, notably out of the automobile industry where the precious metal is used as an autocatalyst to remove harmful emission particles.
Looking ahead, Butterfill argued that we will likely see diminished supply for precious metals like gold and silver as the marginal cost of production rises. As it gets harder and harder to dig out metal ores, the mining sector will have to see significant increases in prices before it becomes profitable to produce more, potentially leading to a supply-side reduction. Butterfill also pointed out that capital expenditures among the top 100 miners is on the decline and will likely continue.
[related_stories]Consequently, ETF Securities believes that precious metals fundamentals look attractive and gold will likely remain resilient, especially after commodity prices have hit a trough.
Related: Gold Demand is Robust
Beyond a potential value play, precious metals also help diversify a traditional investment portfolio since these hard assets show low correlations to traditional stock and bonds, which is especially important in times of uncertainty.
“Commodity exposure in a multi-asset portfolio can add value,” Brian Novak, Senior Managing Director at Astor Investment Management, said.
Novak suggests advisors may adopt a kind of 50/30/20 portfolio instead of the traditional 60% stocks and 40% bond weights. Specifically, investors can still take a heavy 50% stock and 30% bond position but diversify with something like 5% gold, silver, platinum and palladium.
Over the past 15 year period, a portfolio of 60% S&P 500 stocks and 40% in Barclays Aggregate Bonds Index has generated a return of 3.95% with a Sharpe ratio of 0.04. Meanwhile, a 50% stock, 30% bond and 20% precious metals portfolio generated a 4.92% return with a 0.13 Sharpe ratio, or an improved risk-adjusted return over the same period.
Related: Soaring Gold, Silver, Platinum ETFs Power Up
Investors can gain exposure to these precious metals through a number of physically backed ETF options, including ETFS Physical Swiss Gold Shares (NYSEArca: SGOL), ETFS Physical Silver Shares (NYSEArca: SIVR), ETFS Physical Platinum Shares (NYSEArca: PPLT) and ETFS Physical Palladium Shares (NYSEArca: PALL). ETF investors can also use the ETFS Physical Precious Metals Basket Shares (NYSEArca: GLTR) as a catch-all of all four precious metals.
Mike Cameron, Head of Institutional Sales at ETF Securities, also pointed out that since it is difficult to time a rally for a particular precious metal, a broad precious metals basket exposure could potentially provide more consistent returns over the long run and increase diversification.
While many advisors have adopted ETFs, a large group have not diversified with alternative assets like commodities. In a survey of advisors on the webcasts, about 20% of respondents allocate over half of their portfolios to ETFs. However, 44% of those surveyed do not employ some form of commodity ETF in their portfolios.
Financial advisors who are interested in learning more about investment themes for the rest of the year can watch the webcast here on demand.