Diversification Through Precious Metals

Precious metals are materials like gold, silver, platinum, and palladium that are used for industrial, retail, and investment purposes. Within investment portfolios, precious metals can play an important role in portfolio diversification and as a differentiated driver of return. Also, precious metals have historically had a low correlation to traditional assets like stocks and bonds. The most common precious metal is gold, but like any other asset class it is important to diversify.

Gold has historically been used to hedge against inflation because supply is limited. Governments around the world were once held to the “gold standard”, where values of their currencies were linked to the price of gold. Governments now issue fiat currency and are no longer on the gold standard. However, investors have continued to use gold not only for its value in traditional sources like jewelry or electronics but also as an alternative currency that isn’t controlled by a central government. As a result, many investors have used gold as an investment to act as a safe haven or as a potential inflation hedge on fiat currencies like the US dollar. Per the tables below1, gold prices are relatively independent and are not significantly correlated to either stocks or bonds.

While gold has been an inflation hedge in the past, it has not been consistent during the most recent bout of inflation. Per the chart below, gold prices have been weakening even as the inflation rate has been rising.2 One of the potential reasons for this shift has been the invention of alternative cryptocurrencies like Bitcoin and Ethereum. In prior years, when investors wanted to direct assets away from government-based currencies, gold was the primary vehicle for doing so. With the advent of cryptocurrency, there are additional options for investment that may be taking away from potential gold allocations.

While cryptocurrency has been touted as a potential alternative asset class, it is still very new with a short track record of utility combined with extremely high volatility. Further, the methods of investment into cryptocurrency are relatively new and have not been fully vetted through a long period. Lastly, regulators of investment assets (like the SEC) have not yet approved a direct investment into a cryptocurrency ETF. A futures-based Bitcoin ETF was recently approved, but this is not a direct investment into cryptocurrency, but rather an investment in futures trading which can act quite differently than the underlying investment over time.  

Additionally, jewelry makes up ~47% of above-ground gold demand.3 With the ongoing COVID-19 pandemic, many big events have been canceled or delayed, pushing the demand for jewelry back. While gold is the most common precious metal, there are three other primary precious metals: silver, platinum, and palladium. Silver, the second most common is often used as both a store of value and a less volatile industrial use metal. Next, platinum is often used in autos, jewelry, and in electronics. Finally, palladium demand has outstripped supply for years4 as it is used in autos, solar panels, and electronics.

At Gradient Investments there are 2 main places where we invest in precious metals: the ETF Endowment Series and our Precious Metals portfolio. Within the ETF Endowment Series, we own gold due to its low correlation and it being a hedge against inflation. Additionally, within our Precious Metals portfolio, we own a diversified allocation to precious metals, including silver, gold and gold miners. This provides our investors an allocation not only to gold but companies that are leveraged to gold that have high levels of profitability. The allocation to silver diversifies our allocation and provides some exposure to cyclical industries as silver is a significant component in auto manufacturing.  

Sources:

  1. https://www.portfoliovisualizer.com/asset-correlations
  2. https://fred.stlouisfed.org/graph/?g=3WlE
  3. https://www.gold.org/about-gold/gold-supply/gold-mining/how-much-gold
  4. https://www.bbc.com/news/business-51171391