Everyone is scramb-ling to get their hands on metals these days. The Chinese gobble up supplies wherever they can in order to add to their stockpiles. BHP Billiton is trying to tighten its grip on the iron ore industry by taking over rival miner Rio Tinto. And private investors everywhere are squirreling away a rich variety of minerals in their portfolios, from the everyday to the exotic.
The attractions of owning metals are clear. Over the past five years, the Reuters/Commodities Research Bureau (CRB) Precious Metal index is up 199 per cent, while its Industrial Metal index is up 141 per cent. There are also strong diversification benefits to be gained by holding metals directly. Over the past 30 years, industrial metals have had a low correlation with world equities – just 0.2 – while the correlation of precious metals and stocks has been just 0.3.
Hot metals
Of course, past performance is no guarantee of future performance. History shows that periods of strong outperformance in metals are usually followed by big sell-offs. So is there still a strong case for investing in this area of the commodities market and, if so, which metals are most attractive?
It is important to distinguish between industrial and precious metals. The former include the likes of copper, zinc, iron and other materials used in construction, manufacturing and other everyday applications. Precious metals include gold and silver, as well as palladium and platinum. Some of these precious metals are widely used for practical purposes, whereas gold’s main use is in jewellery.
In the event that the world economy suffers a sharp slowdown, demand for industrial metals is likely to suffer – see chart, Industrial metals & world GDP. After all, an international slump would naturally involve a fall-off in construction activity, as well as lower business investment and lower industrial production.
The effect on prices could be especially severe if the drop in demand coincided with increased supply. Producers have been trying hard to expand their capabilities in recent years, but there is a long delay between the decision to open a new mine and the moment when it starts to churn out ores. As a result, it could be that facilities commissioned some time ago will enter production just as the need for metals falls off a cliff.
By contrast, it’s possible that gold could do rather well in an economic slowdown. The precious metal enjoys a reputation among investors for being a safe-haven during times of uncertainty. That's particularly true during inflationary episodes, such as the one seen at the end of the 1970s/early 1980s. Once again, the general price level today is getting out of control across much of Europe, the US and the UK. This could count in gold’s favour. Although it has been a lousy store of value over the very long run, it can hold up well during inflationary shocks.
How to get hold of metals
Interest in owning metals – along with all other commodities – has never been higher. There are more ways to do this than ever before. For longer-term investors, exchange-traded funds (ETFs) are popular – see our article on pages 12-13. For those with shorter horizons, spread betting and other derivative products are often very efficient. However, an attractive alternative for both longer-term investors and shorter-term traders is to deal in physical metals.
Physical ownership is the purest way to get investment exposure. It literally means that you own a quantity of a metal rather than some financial instrument linked to it. Capital Asset Group enables investors to speculate on metals in this way, and also provides some of the financing they require to do so. It offers physical dealing in gold, silver, platinum, palladium, tin, nickel, aluminium, copper, lead and zinc.
Fortunately, physical ownership doesn't mean you have to take delivery personally of a tonne of copper or a gold bar. Capital Asset Group takes care of this on its clients' behalf. So, the customer is registered as the owner of the material, which is held by the company on his behalf in secure facilities. In the case of gold, Capital Asset Group does not charge a fee for either storage or for insurance, which are the two major costs involved in physical ownership.
"If you take a physical position in a metal with us, you're getting a true position in the actual underlying asset and not a portion of some commodity index," says Mark Courtland-Hewlett, a manager at Capital Asset Group. "Many industrial metal ETFs don't always reflect the full extent of moves in the underlying asset."
Another edge that physical trading has over ETFs is that market trading hours are not an issue. "The physical market operates 24 hours a day," says Mr Courtland-Hewlett. "With ETFs, you've got a timeframe of 8am to 4.30pm. But most of the big moves lately have come during Asian market hours and also in the US. With physical trading, you can jump in and out when the price is at the level you want, so you've not any gaps to contend with. This is invaluable for clients who are trading shorter-term."
As with dealing in commodities via derivatives, it is possible to use borrowed money to finance physical positions to ramp up your potential profits. Capital Asset Group will lend customers part of the cost of their position, with the effect that any gains or losses are magnified. "The leverage we offer is non-recourse," says Mr Courtland-Hewlett. "That means your risk is genuinely limited to initial investment, unlike with futures and options where you can lose unlimited amounts."
Gold: you're indestructible
If you’re bearish about the outlook for the world economy, you ought to consider investing in gold. And that goes equally whether you're fearful about an inflationary crisis or a deflationary one. Gold bulls make a credible case that the precious metal would prosper in either of these two nasty scenarios.
Gold's quality as a hedge against bursts of inflation is well known. During the inflationary 1970s, gold's real purchasing power increased by more than six times. By contrast, shares shed much of their value, ending the decade much lower than where they started. However, over the much longer term, gold is a very poor store of value. This is because the substance does not benefit from real economic growth, as equities do.
The fact that gold retains its value in a deflationary crisis is less widely acknowledged. That's partly because there are few such periods in history to choose from – and because the last one was more than 70 years ago. But the deflation that accompanied the Great Depression was a good time for gold. Between 1929 and 1934, its real purchasing power went up by an astonishing 17 times.
As of now, the main economic problem is that of inflation, a result of rampant credit creation in the recent past. However, it's possible that the crisis will eventually evolve into a long, Japanese-style deflationary slump. But deciding to invest in gold is only part of the story here. If you believe in a catastrophe scenario, you also need to think about how you want to hold gold.
"In times of extreme stress, the people who do well from investing in gold are those that own it in a safe jurisdiction," says Paul Tustain, director of BullionVault.com, a company that provides physical exposure to gold. "We give customers the choice of where their gold should be held, and four-fifths choose Swiss vaults. Switzerland has very stable politics, good relations with its neighbours and no trade or budget deficit."
When gold is seen to do well during times of crisis, it inevitably attracts negative attention from politicians, who demonise 'speculators' for the problems that in many cases were caused by politicians. In 1933, the US government even confiscated gold. What's more, derivatives firms can experience difficulties in times of turmoil, which reduces the attractions of holding gold positions via futures or options.
Physical ownership of gold can get around both these problems. "Holding gold in an accredited vault in a secure jurisdiction means you know it's safe and you can get at it when you want," says Mr Tustain. "With an exchange-traded fund (ETF), you're merely the beneficiary of a trust that owns gold, rather than a direct owner."
But if you want to own gold in physical form, why not simply buy gold coins or bars yourself and keep them stashed in a safe at home? Aside from burglary risks, one problem is that coins or small bars will not track the gold market's spot price very accurately. And the transaction costs are likely to eat heavily into your profits. "The difference between your buying price and your selling price with coins or small bars could easily amount to 10 per cent of your total position's value," says Mr Tustain.
By contrast, a position held through a provider such as BullionVault will be of the standard that financial markets formally require. Annual storage costs are around one-10th of what a bank would typically charge a private customer to look after gold, while the difference between buying and selling prices are around 1 per cent at most.
