Part 3 of a 5-part series that diversifies your portfolio with alternative investments.
Welcome back!
In the first two parts of this series - Diversifying Wealth: Real Estate and Diversifying Wealth: Bonds, we discussed a couple of the most common alternative investments to stocks, and the important role they play in portfolio diversification and risk reduction.
The case for diversification can seem tough during periods when other assets are performing so well. Every major financial news publication has been extensively covering the US stock market’s “red-hot” start to the year, as well as similar all-time highs recently set by Bitcoin.
But, what if I told you that there is another major asset class setting record highs, which is rarely being discussed? One that predates other assets such as stocks, bonds, and cryptocurrencies by centuries!
Gold futures are up 11% over the past year, setting a record close on March 11th of $2,182/oz and hovering around that level ever since.
Gold is the largest player in an asset class referred to as precious metals, which have long held a unique and captivating allure on human imagination for centuries. Unlike paper currency, stocks, or bonds, precious metals provide tangible assets that can serve as a hedge against inflation, currency devaluation, and geopolitical uncertainties.
Types of Precious Metals
Gold, silver, platinum, and palladium, are naturally occurring chemical elements that are considered rare and have a high economic value due to their industrial uses, decorative appeal, and role as investments. Here’s a closer look at what makes these metals precious and the historical backdrop that underscores their significance.
Gold, with its unmistakable luster, has been prized by civilizations for over 6,000 years. Ancient Egyptians are credited with some of the earliest mining of gold, utilizing it extensively in jewelry, coinage, and sacred objects. Throughout history, it has symbolized wealth and power, served as currency, and anchored monetary systems, such as the since-abandoned Gold Standard, which linked the value of a country’s currency directly to a specified amount of gold. Its durability, malleability, and resistance to corrosion make it not only a symbol of enduring beauty, but also a staple in modern electronics and medical devices.
Silver's role as a means of trade and store of wealth aligns closely with that of gold, often seen as the more readily available option due to its abundance. Ancient cultures, including the Greeks and Romans, mined silver for coinage and decorative purposes. Its high conductivity and antibacterial properties have expanded its use beyond ornaments and currency to electrical conductors, solar panels, and medical instruments. Its dual role as both an investment and industrial metal continues to influence its price and demand.
Platinum was relatively unknown to the ancient world, due to its rarity and high melting point, which made it difficult to work with. It came into prominence in Europe in the 18th century, with its striking silver-white color quickly becoming valued for its beauty and utility in jewelry, industrial applications, and later as a crucial component in catalytic converters for vehicles. Its rarity, even higher than that of gold and silver, contributes to its status as a symbol of prestige and its value as an investment.
Lastly, palladium is part of the platinum family and shares many of its sister metals’ characteristics. Discovered in 1803, it has become increasingly important in the automotive industry, as well as in electronics, dentistry, and hydrogen purification processes. Like the aforementioned precious metals, palladium’s industrial demand significantly influences its value and investment appeal.
How to Invest
There are several different methods investors can use to gain exposure to precious metals as part of their portfolios:
Physical Metals - Investors can purchase precious metals in the form of bars, coins, or bullions. Investors then physically own the tangible asset and can store it either personally or through a secure third-party service.
ETFs - Exchange-Traded Funds exist for precious metals that are traded on stock exchanges and represent ownership in a pool of metals. These funds track the price of the metal, providing investors exposure without the need to physically hold the metal.
Futures/Options - Contractual agreements to buy or sell a specific amount of metal at a predetermined price and date, allowing investors to speculate on future price movements. As these carry a higher risk of loss and greater complexity, I only recommend this strategy as suitable for very experienced investors.
Mining Stocks - Investors looking for precious metal exposure through the stock market can invest directly in companies involved in the mining and exploration of these materials. Stock performance can be influenced both by the company’s operational efficiency and commodity market price of the metal being mined.
Pros and Cons of Precious Metal Investing
Potential benefits of precious metal investing include:
Inflation Hedge - Historically, precious metals have maintained their value over the long-term, serving as a hedge against inflation and currency devaluation. As the cost of living increases, the value of precious metals tends to increase as well, protecting the purchasing power of your investment.
Safe Haven - During periods of economic uncertainty, geopolitical tensions, or financial market volatility, investors often turn to precious metals as a safe haven. This can drive up prices even when other investments are performing poorly.
Tangible Assets - Unlike digital or paper assets, precious metals are tangible and carry intrinsic value. This physicality can be appealing to investors looking for assets that can be held in hand or securely stored.
Lack of Credit Risk - Precious metals are somewhat unique in that they are not issued by an entity that could default, therefore they carry no credit risk. This makes them a stable store of value independent of any issuer’s financial health.
As far as the bull case for precious metals is concerned, there are some macroeconomic factors worth paying attention to. The rate of new supply being mined is generally pretty consistent on a year-over-year basis.
In recent decades, the discovery of new precious metal sources has slowed dramatically. Based on current extraction technology, it is estimated that within the next 50 years, we may run out of gold that is economically feasible to be mined.
Furthermore, it is worth noting that gold demand from central banks has risen considerably over the last couple years, particularly among developing nations such as China. There are various rationale for these moves, such as shoring up balance sheets from an asset without credit risk, or diversifying reserves away from US dollar overconcentration.
However, despite often being viewed as a “safe haven” investment, precious metals do come with some substantial considerations and risks that investors should be aware of:
Lack of Income - Precious metals do not generate income in the form of dividends or interest. The only return on investment comes from price appreciation, which may not occur over your investment horizon.
Storage and Insurance Costs - If you invest in physical precious metals, you’ll need to consider the costs of secure storage and insurance, which could eat into your investment returns over time.
Volatility - While precious metals can be a hedge against inflation and economic uncertainty, their prices can also be highly volatile in the short term, influenced by market sentiment, currency fluctuations, and global economic factors.
Liquidity Concerns - While gold and silver are highly liquid, other precious metals like platinum and palladium may not be, making them potentially more difficult to sell quickly at market prices.
Regulatory or Market Changes - The precious metals market can be affected by regulatory changes, market manipulation, or shifts in sector demand, particularly for platinum and palladium, which have significant industrial uses.
Another understated risk is opportunity cost - investing a significant portion of your portfolio in precious metals could mean missing out on higher returns from other investments, such as stocks or real estate, which also come with income-generating potential. And, while precious metals are often being thought of as “safe investments”, beginner investors might be surprised to see just how volatile investing in this commodity class can be, with investment gains largely made in recent years based on market timing.
Precious metal investing offers a unique set of advantages, including portfolio diversification, inflation protection, and the security of tangible assets. However, it’s important to weigh these benefits against the potential downsides, and as with any investment decision, consider you financial goals, risk tolerance, and investment horizon to determine if precious metals are a suitable addition to your portfolio.
If you are interested in learning more about a new asset class frequently proclaimed as “digital gold," stay tuned for the next post in this series covering cryptocurrencies!