All that glitters…

As global financial markets exhibit considerable volatility, many investors are searching for assets that typically do not move in tandem with either equities or fixed income.Historically, precious metals have been influenced by a different set of value drivers, creating the potential for effective diversification. There are opportunities for suitable investors in gold, silver, platinum and palladium that may complement investments in equities, fixed income or other assets. 

Supply and Demand

Despite short-term volatility, precious metals have multiple valuation drivers that may provide price support over the long term. These drivers include investment demand, growing industrial use and robust consumer purchases of jewelry, especially in China and India.

• Gold prices have surged in value over the last five years. In 2011 alone, prices climbed from a low of $1,367 per ounce in January to a peak of $1,895 per ounce on September, 6, 2011.Low short-term interest rates have prompted investors to search for returns that exceed those of short-term government bonds and savings products. Concerns about the potential for higher inflation contribute to gold’s appeal as an inflation hedge, and interest in gold jewelry remains strong.
• Silver also reached a record high in 2011, climbing from a January low of $26.68 per ounce, peaking at $48.70 per ounce in April, then falling back to $28.11 per ounce by year end. Investment has accounted for a much smaller portion of the silver market when compared with gold, so valuations depend more on the industrial economic cycle. Silver is used extensively in superconductors, vehicles, photovoltaics and other industrial applications.
• Platinum and palladium are used to make catalytic converters for automobiles, jewelry and liquid crystal displays in consumer electronics. These uses create a situation where, like silver, prices depend heavily on the state of the industrial economy. Prior to recent escalation of gold valuations, platinum prices frequently exceeded those of gold, partly because the supply of platinum is smaller.

Correlation: Key to Effective Diversification

Precious metals present value as portfolio diversifiers because their long-term returns historically have not moved in tandem with equities or fixed income. This tendency is measured by a statistic known as correlation. A correlation close to 1 indicates that two assets historically have moved in tandem in response to economic or market developments. A correlation close to zero indicates there has been no relationship between returns, and a correlation close to -1 indicates that returns have moved in opposite directions.

Correlations of 36-Month Returns Beginning January 2, 1991, and Ending June 30, 2012

U.S. Equities

U.S. Bonds

U.S. Equities

1.00

0.03

U.S. Bonds

0.03

1.00

Gold

-0.53

-0.44

Silver

-0.02

-0.49

Platinum

-0.25

-0.48

Palladium

0.55

-0.16

(Source: S&P Capital IQ Financial Communications)

Ways to Invest

When using precious metals as a portfolio diversifier, there are a number of ways to invest

• Specifically identified metals (bars). Specifically identified metals are bars that are distinguished by a serial number or other unique marker that identifies them as belonging to you. Once purchased, you can either take direct possession or decide where your metals investment is stored, insured and managed. Storage costs are generally higher for specifically identified metals than for allocated and unallocated metals.
• Allocated account. In an allocated account, your precious metals (bars and coins) are stored with those owned by other investors, but no specific asset is identified as belonging to you. Storage costs are generally higher than those for unallocated metals.
• Unallocated account. Unallocated metals cannot be physically delivered. Your investment is held in book-entry form and represents a share of interest in a pool of precious metals. When you redeem your interest, you receive the corresponding market value of the investment, less any fees and costs.

 Help in Managing Risk

It is important to understand that precious metals historically have generated considerable short-term volatility. Which investments best complement your portfolio will depend on a number of factors, including your existing holdings and appetite for risk.