How to invest in precious metals – part 1
Buying gold and silver bullion will always be the ultimate crisis hedge, but in today’s world we are faced with a wide range of alternatives when investing in precious metals, that can make a decision complex.
ETFs, mutual funds, bullion etc. are becoming increasingly popular and it can be difficult to understand the differences between all of the available options. In some cases you will be giving up security for perceived flexibility, so it’s important that you make an educated decision before going ahead with an investment.
In this two-part article series we take a closer look at the different ways of investing in precious metals. In future articles, we’ll look deeper into the risks and rewards of each of these alternatives.
Buying gold stocks is an option for the investor that feels comfortable in making a conscious decision between different types of stocks traded on an exchange. That is easier said than done though, as the precious metals stocks can be highly volatile.
In this space there are different types of companies – established miners, junior miners and royalty companies. Established miners have existing mining operations whereas the junior miners often are in an exploration phase, which can be highly capital intensive and risky. Royalty companies typically help provide financing to miners and receive a payment stream in the future in return – if the operation proves successful.
Precious metal stocks do have a correlation to the spot price of gold, silver etc. but there are many other factors that influence the stock prices. In most cases, investing in precious metal stocks is a speculative play that can offer great reward but also great risk.
For those investors who feel less comfortable picking stocks themselves, mutual funds are an attractive option. These funds hold portfolios of precious metal stocks that typically are more established and which produce a known quantity of gold, silver, platinum or palladium each year.
Choosing a mutual fund provides the same type of exposure to spot prices as single stocks do, which is to say limited, but there is generally a lower price risk as the fund will hold several companies in their portfolio.
Exchange traded funds (ETFs) have become increasingly popular over the last few years, since they offer a very flexible way of investing in precious metals. An ETF is a type of mutual fund that trades on a stock exchange like an ordinary stock. They can consist of precious metal stocks or of actual physical gold, silver, platinum or palladium.
With an ETF you will thus have a real exposure to the spot price, but there are caveats. In many cases there are also questions on whether the funds actually match the full exposure of the fund with ownership of physical bullion. In any case it will be difficult for investors to covert their shares to actual bullion, as most funds reserves the right to settle in cash. The correlation to actual spot prices will be higher than when investing in precious metal stocks, but depending on the exact type of ETF it can still vary.
Leveraged ETFs should be considered short-term speculative instruments. Unleveraged ETFs are a good way of gaining exposure to precious metals for the longer term, but these funds still don’t provide the same level of security as actual physical ownership of bullion.
Stocks, mutual funds and ETFs all have advantages such as ease of buying and selling, transparent and in some cases low management fees. They are however in their nature more speculative plays on prices, rather instruments of insurance and crisis hedges. In a real crisis scenario there is no telling if the net asset value of funds would plunge or if exchange prices for ETFs would divert completely from the price of physical bullion. We’ve already seen examples of this during the last few months.
In the next part of this article series we look at the remaining options available for investing in precious metals.