Precious metals offer excellent diversification opportunities due to a low correlation to other assets, protection against rising inflation and act as a hedge against geopolitical events.
They offer the potential for strong returns in extreme environments when equities and bonds may struggle. Yet gold alone has a unique role as a central bank reserve asset. This means it is increasingly seen as a currency. And with central banks pushing rates down to zero and printing money, no currency has performed as well since the spring of 2009 when the US Federal Reserve initiated its first round of quantitative easing.
Gold's re-entry into the mainstream after two decades off the investment agenda is well illustrated by the fact that JPMorgan started to accept physical gold as collateral for some transactions in February of this year.
For more expert opinion on the yellow metal, read: Gold: An IFA's view.
Incorporating forms of exposure to precious metals other than gold bullion into the mix adds another level of diversification and can potentially boost performance. There are two obvious alternatives: other precious metals and shares in gold and precious metal miners.
Silver is often seen as the poor man's gold. Because silver is more cyclical than gold, with more than 50% of demand being for industrial use, the price tends to be more volatile.
Palladium and platinum also have a higher percentage of industrial usage. In the medium term, palladium, which is heavily used in the auto industry, will benefit from rising demand from China and other emerging markets. Platinum will benefit from stricter emission control regulations and supply constraints in South Africa, where 90% of the metal is produced.
The disadvantage of this industrial usage is that price of these metals typically underperform gold in an economic downturn, which is exactly when investors are looking for positive returns from their non-equity holdings.
The performance of gold mining shares is less predictable. For recent investors in gold shares, it must seem as though gold shares typically underperform when equities are struggling. This sounds intuitively right. And yet, in 2002, when the S&P tumbled 25% and the gold price rose 25%, the Philadelphia Gold and Silver index soared more than 40%.
The recent underperformance of gold shares can be partially explained by the rise in oil prices, which pushes up costs for the miners. It may also be explained by the rise in gold exchange traded funds (ETFs), offering investors a ready alternative to gold shares. We see the de-rating of gold shares as an opportunity and are positive on the outlook for the listed gold miners.
The final alternative can be quickly dismissed. For many years gold was ignored by investors who felt that derivatives offered a more elegant form of portfolio protection.
The collapse of Bear Stearns, AIG, Lehman et al changed that forever (or at least for a generation).
Any structured product offering upside to the gold price and protection on the downside misses the point that owning gold is a way of avoiding taking on any form of collateral risk. Indeed, taking this into account, you could argue that gold still looks cheap. Excluding the decade prior to the financial crisis, gold is trading close to the lows.
