The world of investments offers many diversified asset classes to individuals to place their hard-earned money. Investors consider investments in various asset classes for different purposes. A few of the reasons include expectations of higher returns, protection from inflation, and security against economic recession based on the belief that certain investment classes act as a good hedge.

Investment in various metals has emerged as a viable option for investors who are looking for such benefits. Precious metals, such as gold and silver, are believed to be a good hedge against inflation. They are also perceived by common individuals as the most secure form of investment, considered much less risky compared to even the safest risk-free government bonds.

Analyzing historical data, this article explores whether it is really worth investing in metals, and whether they actually provide hedging against inflation and economic slowdown. We look at the different kinds of metal categories, their past performances, price determining factors, and the various instruments available for investing in metals.

The World Of Metals Investments

For investment purposes, metals are categorized into three broad streams: base metals, precious metals, and rare earth metals.

  • Base Metals: Due to high abundance and easy availability across the globe, prices of base metals are usually low compared to other metals. Base metals are used for industrial and commercial purpose and include metals like zinc, copper, aluminum, lead, tin, nickel and iron. (Related: What does it mean to invest in base metals?)
  • Precious Metals: Gold and silver, along with the other two lesser known precious metals, platinum and palladium, constitute the precious metals category. Due to their scarce availability, these metals have high valuations. They are used in jewelry, electronics, medical equipment and industrial work. (Related: A Beginner's Guide To Precious Metals)
  • Rare Earth Metals: The rare earth metals group comprises lanthanum, cerium, praseodymium and neodymium. These metals are finding increasing usage in electronic devices, military and defense appliances, weapons and stealth technology. These metals are not necessarily rare to find, but their specialized usage and specialized extraction and processing makes them unique. (Related: Understanding Rare Earth Metals)

    Metal Investment Options

    Investing in metals is available through various financial instruments.

    • Physical metal: One can simply purchase physical metal in the form of coins, bars, or other available artifacts and store it in a safe. However, such physical forms of investments have the additional expense required for safe storage.
    • Metal-specific ETF: One can purchase metal-specific ETFs which may invest in one single metal, or a basket of metals. Care should be taken to understand the fund holdings, as some of the ETFs may also hold metal future contracts, instead of purchasing physical metal. (See What are the most common ETFs that track the metals and mining sector?)
    • Metal-sector-specific mutual funds: If one is good with end-of-the-day NAV valuation, then there are several mutual funds that offer diversified investment in selected metal stocks. Metal-specific mutual funds mainly invest in a basket of stocks belonging to companies operating in metals and mining sector. (See What are some of the most popular mutual funds for investing in the metals and mining sector?)
    • Stocks of metal companies: One can also buy stocks of companies operating in metal sector. Examples include NYSE-listed Eldorado Gold Corp (EGO), which operates metal mines across the globe.
    • Metal commodity futures: One can also take positions in metal contracts for trading purposes.

    Historical Performance Of Metals:

    Here are the historical price variations of a few of the metals over the last 10 years:

    Aluminum Prices: (Graph Courtesy LME):

    Aluminum Prices

    Copper and Gold Prices: (Graph courtesy NASDAQ)

    Copper and Gold Prices

    In the above graphs, high volatility is observed in each metal price.

    • Aluminum prices have essentially declined from their levels of mid-2007, amid high volatility.
    • Copper prices have increased over the last 10 year period, but with very high volatility. Compared to the intermediate highs of 2011, present-day copper prices are actually down significantly.
    • Gold prices too have been very volatile, and off their 2011 highs.
    • All metals suffered price declines during the 2009 global recession.

    An important point to note is that there are no corporate actions like dividend payments or stock-splits on metal prices, which can justify decline in prices due to corporate action adjustments, or intermediate payment of dividend income.

    In a nutshell, prices of metals show a very high level of volatility, and are prone to global factors, economic slowdown, and demand and supply.

    Here is another look at the metals investment and their historical valuations using another popular investment vehicle: Exchange Traded Funds (ETF).

    ETFs closely mirror the performance of the underlying asset. Here’s how the different metals have performed over the last 5 years.

    Graph Courtesy: Google Finance

    Metal ETF Performance

    The comparative graph includes return percentage for base metal ETFs (Copper – JJC, Aluminum – JJU, Nickel – JJN), precious metals ETFs (Gold – GLD, Silver – SLV) and a composite rare-earth metals ETF (REMX).

    Similar to the physical metal prices represented in the above graphs, the ETF prices also demonstrate a high level of volatility, and a general decline in returns.

    The composite rare earth metals ETF (REMX) has been the worst performer among the ETF’s, with up to -80% losses in last 5 years. Other metals, including precious metals gold and silver, too have failed to generate positive returns.

    Reasons For Investment In Metals

    Regardless of their realistic applicability, the following are the primary reasons why common individuals prefer investments in metals:

    • Diversification: Metals are a completely different asset class than common equity, bonds and currency. Their valuation is driven by demand and supply, geopolitical situations in regions of primary metal sources and seasonality factors. Unlike a stock, metal prices aren’t dependent on management of a company, efficiency of business operations, or percentage market share. Their prices represent their core intrinsic value. Adding them to the portfolio in appropriate proportion allows a good level of diversification. (Related: Introduction To Investment Diversification)
    • Hedge against inflation: Inflation is a silent killer, as it erodes the real gains on an investment. Prices of precious metals, such as gold, are perceived to increase in sync with inflation. If a basket of selected everyday goods cost $100 today and inflation is 10%, the same basket of goods will cost $110 one year later. An understanding among common individuals is that the gold price will also move in tandem (10%) with inflation. Such beliefs are also important reasons to invest in metals, especially precious metals.

      Graph courtesy: TradingEconomics

      US Historical Inflation

            It can be observed that inflation in the US has remained more or less in the stable range defined between -2 and +6 percent in the last 10 years, but gold prices (above) have been very volatile and mostly out of sync with inflation numbers. This refutes the common belief that gold can act as a good hedge to inflation.

      • Protection against economic downfall: If the economy collapses for any reason, it may lead the national currency (like the US dollar) to decline in value. A common behavior observed in such cases is that individuals revert to investing in precious metals like gold and silver. The underlying belief is that such metals remain shielded and decoupled from the economic developments, and their valuation does not go down in sync with the currency or economy as a whole.
      US GDP

      The GDP numbers over the last 10 year period are not in sync with any of the metal price changes. Despite a clear dip in 2009 due to global recession, the price of aluminum, copper and gold were down. If this common belief were true, the prices of these metals during this period should have at least maintained their levels. Contrary to that, metal prices went down significantly.

      • Limited risk concentration: Another common belief concerning metals investment is that risk is confined only to the large metal- producing nations or regions, and their geopolitical situation. An economic slowdown or political unrest in gold-producing nations like South Africa or Australia can lead to high prices of gold globally. Since such region- or nation-specific challenges are somewhat rare, it provides risk cover substantiating this belief to some extent. In the present day hi-tech world, price determination occurs at global exchanges and markets, following global demand and supply situation. Hence, metal prices are less prone to manipulation, offering efficient prices to investors who trade in well-regulated markets. However, the intrinsic risk of losses due to price declines remains.

      Important Investment Pointers

      • Avoid overinvestment: Based on historical price observation, it is evident that metal prices depend on a few important factors such as demand and supply, and the geopolitical situation in the countries of primary source of metals. High volatility in prices is a common phenomenon across the entire metals segment, hence overexposure is not advised.
      • No returns guaranteed: Even in the long term spanning 10+ years, the returns may not be guaranteed as seen in the graphs illustrated here.
      • No dividends: A holding in gold, silver, nickel or aluminum is completely different from holding an equity investment which is business ownership, or a bond which is an interest-bearing security. Equities pay dividends, which is essentially a part of business profits or extra cash lying with the company. A dividend acts as the unsung hero for the long-term investors who get regular income in small chunks. Unfortunately, metal holdings don’t pay anything, even over a longer duration.
      • High volatility: In the last 10 years, metals have emerged as active traders’ products, rather than investors’ products. Even among the trader community, only a select few have managed to reap real profits, as transaction costs take away a sizeable portion.
      • Taxation needs to be considered for metals investments, as metals trading may attract higher taxes on income. There may also be a transaction tax levied on metals trading.  

      The Bottom Line

      Although commonly perceived as a safe investment class for hedging against inflation and economic slowdown, the historical performance of different metals raises some red flags. Returns have been subdued even in the long term, and short-term trading has been hit by high volatility. Treasury Inflation Protected Securities (TIPS) can be a good option against inflation, compared to gold and other metals. Instead of betting on overall metal prices which are driven by global factors, one can take stock of specific positions after careful study of metal- and mining-specific companies.