What Are Precious Metals?
Precious metals is a term for the classification of metals that are considered to be rare and/or have a high economic value. The higher relative values of these metals are driven by various factors including their rarity, uses in industrial processes and as investment vehicles. The most popular precious metals with investors are gold, platinum and silver, and precious metals used in industrial processes include iridium, which is used in specialty alloys, and palladium, which is used in electronics and chemical applications.
- Precious metals include valuable commodity materials including gold, silver, and platinum.
- Gold and silver have long been recognized as valuable metals, and have been coveted since ancient times.
- Modern investors seek an allocation to precious metals as a portfolio diversifier and hedge against inflation.
- Traders and investors can buy metals through several mechanisms including owning physical bullion or coin, derivatives markets, or metals ETFs.
Understanding Precious Metals
Investors can invest in precious metals by purchasing the physical asset, purchasing futures contracts for the particular metal or through the purchase of shares in publicly traded companies engaged in the exploration or production of precious metals. Mutual funds and exchange-traded funds (ETFs) also offer a variety of strategies, including funds backed by bullion, portfolios of mining companies and leveraged exposure.
As an investment, precious metals are sought after to diversify portfolios and as a store of value, particularly as a hedge against inflation and during times of financial uncertainty. The single most popular precious metal for investment purposes is gold, followed by silver, and there are several options for gaining exposure.
Several factors account for an increased desire to hoard the shiny yellow metal:
- Systemic financial concerns: When banks and money are perceived as unstable and/or political stability is questionable, gold has often been sought out as a safe store of value.
- Inflation: When real rates of return in the equity, bond or real estate markets are negative, people regularly flock to gold as an asset that will maintain its value.
- War or political crises: War and political upheaval have always sent people into a gold-hoarding mode. An entire lifetime's worth of savings can be made portable and stored until it needs to be traded for foodstuffs, shelter or safe passage to a less dangerous destination.
How to Trade Precious Metals
Precious metals can be purchased and held in the form of bars or coins. Gold bars typically carry a very low margin over spot prices, but can be cumbersome. Gold coins such as the one-ounce South African Krugerrands also trade close to spot prices and offer more flexibility for investors who are buying or selling in quantities less than 400 troy ounces, which is the standard gold bar size.
A wide variety of commodities are traded in the futures market, including precious metals. Futures offer investors a leveraged means of buying or selling precious metals, set at a specific price and time in the future. Futures are generally viewed as speculative vehicles, but they can also be used to lock in prices for purchases and sales of physical commodities. Options markets also exist for many precious metals.
Publicly traded mining companies offer exposure to precious metals at the producer level, but this category has underperformed other vehicles due to a variety of challenges including high company debt levels, rising labor costs and environmental issues. In addition to subpar performance, buying individual producers magnifies risk when compared to diversified holdings.
For investors seeking diversified exposure to precious metals mining companies, there are numerous mutual funds offering exposure in varying geographies and markets caps. Investors can select between funds that limit holdings to specific areas or invest globally, as well as in large gold mining concerns or junior producers.
The widest range of investment strategies for precious metals can be found in exchange-traded funds with options including junior and senior producers, gold bullion, and leveraged exposure. In addition to offering numerous strategies, ETFs offer the advantage of daily liquidity and low transaction costs.
Precious Metals Risks
Every investment comes with its own set of risks. Although they may come with a certain degree of security, there is always some risk that comes with investing in precious metals. Prices for metals can drop during times of economic certainty, putting a damper for people who like to invest heavily in the precious metals market. Selling may be a challenge during times of economic volatility, as prices tend to shoot up. Finding a buyer for physical metals may be difficult.
Another risk to precious metals prices includes the issue of supply. When demand shoots up, the existing supply may begin to deplete. And that means producers will have to bring more of each metal into the market. If there is a short supply of mineable metals, that could put pressure on prices.