A primer for any investor considering the precious metals market...
GOLD IS THE granddaddy of precious metals. It's been used as money for as long as money has been around, and for good reason.
Gold is easily identifiable, easily minted, nearly indestructible, and quite limited in supply. And despite the fact that the reality of "Gold is Money" has all but evaporated, it still serves the world as the primary store of value outside of currency.
That gold has significant value is almost entirely because of convenient fiction. Jewelry is made from gold for aesthetic reasons, and because of its association with wealth. Gold is stored in bars and coins because people believe it will retain and potentially appreciate in value. But gold, in and of itself, has limited utility. It's an excellent conductor, so it gets used in circuits, high-end stereo connectors, and such. It's got optical properties that make it useful for satellite reflectors and other obscure applications. Because it's so malleable, dentists use it for fillings.
But in terms of actual demand, industry barely matters – less than 20% of the gold sold every year goes to a "useful" buyer. The rest goes into jewelry and the mattresses of investors. If the collective delusion that "gold is valuable" disappeared overnight, then perhaps gold would be used in all sorts of industrial applications...because suddenly, it would get cheap.
As it is, gold's usefulness is limited precisely because of its value.
For investors, the Gold Market is attractive because of its value-store characteristics. It remains a fact that an ounce of gold has been a useful measure of value for centuries. This is a completely valid reason to own it.
More than any other precious metal, gold trades in reaction to macro-events and speculation. It is the place conservative investors plow their money in response to geopolitical turmoil, and where inflation hawks look for sacred ground. It is, for most investors, a hedge against "really bad stuff". When it gets nasty out there, you want to own gold.
Living on its own, silver is a far more useful metal than gold. Silver shows up in myriad ways – water purification, electronics, solar panels, medical devices, batteries. One of the largest uses of silver remains photography. Silver crystals are the magic that has made pictures work for almost 200 years. And despite the rise of digital photography, plain old silver halide film isn't actually disappearing as fast as you might think.
Silver film remains cheap, permanent, and is well entrenched in industrial photography (like X-rays). But silver is also money, in this case literally. Mexico still mints 2 million ounces of coins that go into circulation every year. Beyond Mexico, silver isn't widely stamped out into coins which circulate. Rather, the mints use silver like they use gold – as bullion. And its use as money spills over into jewelry and silverware.
But while all these non-industrial uses have the same perception-based problems in common with gold, the two metals are distinctly different, because the long-term case for silver's industrial use remains strong.
Unlike gold, when silver gets used in an industrial application, it's generally consumed and doesn't enter the supply (outside of recycling from photographic uses). And the industrial uses of silver go up every year, especially in electrical and medical applications.
On the supply side, silver is more complicated than gold. New gold supply comes essentially from one place – gold mines, although there is a little central-bank supply, too. Silver more often than not comes as a byproduct from multi-ore mines, coming along for the ride with lead, zinc, copper and gold. So silver supplies can rise and fall not just in response to demand, but in response to demand for all those other metals as well. That makes it hard to judge supply/demand factors for the metal.
Silver, however, does not live in an industrial vacuum. Just as goldbugs often have a near-conspiratorial belief that there is a "correct" price for gold in relationship to the Dow, inflation, or sunspots, so too precious metals investors point to historical relationships between gold and silver. This relationship is only of interest because they both live in the same investor brainspace as stores-of-value.
Ten seconds in Google will uncover what this "correct" ratio is, and that's 15 to 1. Every ounce of gold should buy you 15 ounces of silver, give or take. The reason behind this is often lost in translation, but comes down to the same musty thinking that drives people to assume gold must be valuable in the first place. Back in the 1800's, for reasons based not on natural laws but on minting and convenience, England, France, and the United States separately set the value relationship between gold coins and silver coins such that, by weight, the 15-1 relationship was more or less intact.
But throughout the 20th century, as gold and silver were demonetized (legally removed from their relationship to money), the ratio has exploded. An ounce of gold as of this writing buys you 56 ounces of silver, give or take. But to use this as the reason for a bull-run in silver for the next 100 years seems a bit far fetched.
We prefer to fall back on Jim Rogers' logic – nobody can repeal the law of supply and demand.
Sure, it's pretty, but platinum gets used for its pretty and value properties far less than gold – less than 20% of it ends up in wedding rings a year. And overall, there's way less of it in circulation on a given day than there is in gold: total production is less than 5 percent of gold's every year.
Here's a cocktail party stat: All the platinum ever mined would fit in a 25 foot square room. Much ado about not-so-much.
Supply, however, remains incredibly tight. Virtually all of the platinum and palladium in the world comes from one of two regions: South Africa and the most extreme reaches of Siberia.
This tight supply butts against very real demand based on a lot more than that 20 percent that ends up in jewelry. Platinum gets used in all the strange and wonderful ways the rest of the precious metals do – catalytic converters in cars, inside medicines, in electronics, in diesel engines.
Now platinum is coming into its own as an investment. While platinum showed a surplus for the first time in decades in 2006, the market remains so tight that even a modest uptick in demand from investors can have a big impact. Jewelry, coinage, and ETFs aren't huge factors in the platinum equation today, but as commodities in general and precious metals in particular become more mainstream, platinum is poised for substantial growth – or at least, substantial volatility.
The Bleeding Edge
Gold, silver and platinum get most of the attention, and for investors, deservedly so: it's hard to buy anything else. Just as most investors aren't going to find a decent pure play investment in lead, so too with the minor precious metals (at least until ETF Securities started launching precious metals ETFs earlier this year).
The platinum group in particular (palladium, ruthenium, rhodium, and iridium) is most easily accessed through other methods – the markets for the metals themselves aren't futures-based, aren't traded as financial assets, and are in general thinly traded. There's just so little of it to go around that unless you really NEED that iridium, you're not likely to be in the market for it.
Precious? Metal? Most of the time we want the stuff as FAR away as possible, and it comes in flakey "yellowcake." Because the market for Uranium as an investment is still young and mostly illiquid, it's generally not put in any category when folks like us divvy up the universe. So we'll put it here.
We've covered the rise of Uranium as an investment idea for some time at HardAssetsInvestor.com. The demand is certainly out there, and the supply well understood. It's only the vehicles and processes for buying it, selling it, and storing it as a commodity that are problematic. For the moment, Uranium remains a "buy the company" play, but as the idea of Uranium as an investable commodity takes off (and after its 700% rise, it should), keep your eyes open for better ways to make purer plays.
More than any other commodities, precious metals offer the full range of investment options – spot, stock and futures. Actually owning the physical commodity is incredibly easy in the big three. Bullion dealers like Kitco will sell you physical coins and bars for delivery (you can even get palladium bars), as well as shares in a gold pool. BullionVault.com gives you direct access to the live spot market, cutting your costs to a minimum and providing you with economic interest in the physical metal without the pesky delivery problems.
More interesting for higher-risk investors is the liquidity of the futures market. Gold, silver and platinum are heavily traded on the New York Mercantile Exchange (Nymex), and palladium and even uranium have contracts, although not with the kind of liquidity most individual investors have come to expect.
As always, "buying the cow" remains an option. Most of the major gold mining companies (Barrick Gold, Newmont Mining) have ancillary and not-so-ancillary businesses in the other precious metals. The notable exception is in platinum, where, as we pointed out, production is concentrated in a very few places (Platinum Group Metals (AMEX: PLG) remains one of the only pure plays on the US exchanges).
Increasingly, it's pooled vehicles (ETFs, ETNs and Mutual Funds) where investors can get easy and effective access to precious metals. Bullion-based ETFs – where shares represent an interest in a physical vault full of metal – provide the cleanest exposure, but lack outright ownership rights for their investors. ETFs exist for both gold and silver, with the StreetTRACKS Gold ETF holding over $10 billion in assets.
On the London Stock Exchange, ETFs now hold palladium and platinum, in addition to gold and silver, although a similar launch in the US was apparently scuttled due to lack of perceived demand (not to mention a planned sales-boycott of all platinum ETFs by Anglo Platinum of South Africa. They think platinum should be used, not hoarded.)
It's All Shiny
While there are many ways to skin the cat, choosing a precious metals strategy has much more to do with your goal than your vehicle. Most investors are drawn to precious metals because of gold and silver and their historic role as value-stores. They are perceived by many as places to stick money in times of crisis and as a hedge against inflation. We won't claim that these aren't valid considerations, but investors need to go in knowing that they are investing in perception, not reality.
Platinum investors, on the other hand, are investing primarily in an extremely scarce industrial commodity; one a lot more glamorous than say, copper, but nonetheless, a commodity of utility more than a commodity of vanity.
But in both cases, there is something attractive about physically holding on to something that the market ascribes value to. Deep inside all of us, there's a 90-year old curmudgeon with a mattress full of silver dollars just waiting to come out. Whether you give him reign is up to you.