All That Glitters: Investing in Precious Metals

Precious metals historically have not moved in tandem with either equities or fixed income. This tendency enhances their appeal as a portfolio diversifier.

By Todd Hauer; Wealth Advisor, Global Wealth Management Division of Morgan Stanley- Denver Tech Center
Posted

As global financial markets exhibit considerable volatility, many investors are searching for assets that typically do not move in tandem with either equities or fixed income.1 Historically, precious metals have been influenced by a different set of value drivers, creating the potential for effective diversification.2 There are opportunities for suitable investors in gold, silver, platinum and palladium that may complement investments in equities, fixed income or other assets.

Supply and Demand 

Despite short-term volatility, precious metals have multiple valuation drivers that may provide price support over the long term. These drivers include investment demand, growing industrial use and robust consumer purchases of jewelry, especially in China and India.

  • Gold prices have surged in value over the last five years. In 2011 alone, prices climbed from a low of $1,367 per ounce in January to a peak of $1,895 per ounce on September, 6, 2011.3 Low short-term interest rates have prompted investors to search for returns that exceed those of short-term government bonds and savings products. Concerns about the potential for higher inflation contribute to gold’s appeal as an inflation hedge, and interest in gold jewelry remains strong.
  • Silver also reached a record high in 2011, climbing from a January low of $26.68 per ounce, peaking at $48.70 per ounce in April, then falling back to $28.11 per ounce by year end.4 Investment has accounted for a much smaller portion of the silver market when compared with gold, so valuations depend more on the industrial economic cycle. Silver is used extensively in superconductors, vehicles, photovoltaics and other industrial applications.
  • Platinum and palladium are used to make catalytic converters for automobiles, jewelry and liquid crystal displays in consumer electronics. These uses create a situation where, like silver, prices depend heavily on the state of the industrial economy. Prior to recent escalation of gold valuations, platinum prices frequently exceeded those of gold, partly because the supply of platinum is smaller.5

Correlation: Key to Effective Diversification

Precious metals present value as portfolio diversifiers because their long-term returns historically have not moved in tandem with equities or fixed income. This tendency is measured by a statistic known as correlation. A correlation close to 1 indicates that two assets historically have moved in tandem in response to economic or market developments. A correlation close to zero indicates there has been no relationship between returns, and a correlation close to -1 indicates that returns have moved in opposite directions.

Correlations of 36-Month Returns Beginning January 2, 1991, and Ending June 30, 20126

 

 

U.S. Equities

U.S. Bonds

U.S. Equities

1.00

0.03

U.S. Bonds

0.03

1.00

Gold

-0.53

-0.44

Silver

-0.02

-0.49

Platinum

-0.25

-0.48

Palladium

0.55

-0.16

Ways to Invest

When using precious metals as a portfolio diversifier, there are a number of ways to invest.

  • Specifically identified metals (bars). Specifically identified metals are bars that are distinguished by a serial number or other unique marker that identifies them as belonging to you. Once purchased, you can either take direct possession or decide where your metals investment is stored, insured and managed. Storage costs are generally higher for specifically identified metals than for allocated and unallocated metals.
  • Allocated account. In an allocated account, your precious metals (bars and coins) are stored with those owned by other investors, but no specific asset is identified as belonging to you. Storage costs are generally higher than those for unallocated metals.
  • Unallocated account. Unallocated metals cannot be physically delivered. Your investment is held in book-entry form and represents a share of interest in a pool of precious metals. When you redeem your interest, you receive the corresponding market value of the investment, less any fees and costs.

Help in Managing Risk

It is important to understand that precious metals historically have generated considerable short-term volatility. Which investments best complement your portfolio will depend on a number of factors, including your existing holdings and appetite for risk. Let me work with you to identify the precious metals investments that best suit your specific needs.

Footnotes/Disclaimers

1Investing in stocks involves risks, including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.

2Investing in the precious metals sector involves special risks, including those related to fluctuations in the price of precious metals and increased susceptibility to adverse economic and regulatory developments affecting the sector. It may also be subject to the risks of currency fluctuation and political uncertainty associated with foreign investing. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.

3Source: World Gold Council.

4Source: London Bullion Market Association.

5Source: The Wall Street Journal, “Palladium Could Be Set to Soar as Cars Drive Demand and Supply Is Sketchy,” May 19, 2012.

6Source: S&P Capital IQ Financial Communications. Stocks are represented by the S&P 500; bonds by the Barclays Aggregate Bond Index; gold, silver, platinum and palladium by prices per ounce in U.S. dollars on the London fix. You cannot invest directly in an index. Past performance does not guarantee future results.

 

Todd Hauer is a Wealth Advisor and Senior Investment Management Consultant with the Global Wealth Management Division of Morgan Stanley in Denver.  He can be reached at Todd.Hauer@morganstanley.com or 720.488.2406.

The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives.  Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Wealth Management, Member SIPC, or its affiliates. Morgan Stanley Wealth Management LLC. Member SIPC.

 

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