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Many investors believe their portfolios have
exposure to precious metals because they hold stocks in mining companies. But
as a safe haven, no gold or silver or platinum stock (or even an ETF)
compares with physical bullion.
Let’s examine why physical bullion is the superior investment.
While mining stocks can provide attractive returns at times, they simply do
not have the same risk-reward relationship or non-correlation to traditional
financial assets as an investment in physical bullion. It is this key
attribute of bullion that enables investors to reduce portfolio risk and obtain
real diversification. Without an allocation to physical bullion, an
investment portfolio is neither balanced nor diversified. In addition to the
risk reduction provided by diversification, only bullion can protect
portfolios against non-diversifiable systemic risks. During a financial
crisis or a severe stock market decline, bullion tends to outperform mining
stocks – often quite dramatically. Without physical bullion portfolios
are neither balanced nor diversified.
Many investors, particularly North American investors, believe that holding
mining stocks is the same as holding bullion. This is a widespread
misconception. Mining stocks and bullion are entirely different asset
classes.
Each asset class – stocks, bonds, cash real estate, commodities or precious
metals – has very different risks, volatility, and, most importantly,
correlations. The performance of mining company shares can be adversely
affected by a host of factors such as stock market volatility, geopolitics,
environmental issues, management capability, financial strength, mine life,
productivity, increases in operating costs, energy supplies and hedging
policies, even when the price of bullion is rising. Ultimately, mining stocks
are a promise of performance by the management team. Bullion, on the other
hand, does not rely on anyone’s promise of performance and cannot
decline to zero, as the shares of many mining companies have in the past.
Bullion offers superior performance during monetary uncertainty
During a secular bull market in precious metals that is driven by monetary factors, bullion tends to outperform mining stocks. This
is because, globally, investors will turn to physical bullion as a safe
haven, rather than to shares of mining companies. This phenomenon was
confirmed in the 1970s gold bull market, when the US dollar experienced
significant declines, just as it is today. The monthly closing prices of
shares of Homestake Mining, the largest North
American producer at that time, increased by a respectable 8 times. The
monthly closing price of gold, however, increased by 15-fold.
 
While many junior mining companies outperformed Homestake
in the 1970s and produced impressive returns for their shareholders, many
others faded into obscurity, resulting in painful losses. The risk-reward
relationship for junior mining companies and bullion is simply not
comparable. However, if you have a high-risk tolerance and a good advisor,
then a small allocation to junior mining companies may be appropriate. Apart
from junior mining companies, mining stocks in general need to achieve
significantly higher returns than bullion in order to adequately compensate
investors for increased risk and volatility.
During the 1987 crash, gold rose while mining stocks declined
While mining shares generally tend to track the price of bullion, they are
still stocks. As such, they can become correlated to the broad equity
markets. At the beginning of a bull market, it is well documented that mining
shares typically rise, and may even outperform bullion. However, as economic
or market conditions deteriorate, global investors will inevitably seek a
safe haven for their wealth, as opposed to speculative investments. Thus,
bullion eventually outperforms the shares. That is why, during broad-based
equity declines, mining stocks typically correlate to the equity markets and
not to the price of bullion. For example, in the 1987 stock market crash, the
Dow declined by 35% and the XAU mining stock index declined by 42%, while the
price of gold rose.
Recent comparative performance
This non-correlation is apparent in today’s markets. In the year to
date, gold increased by 11%, silver by 18% and platinum by 25%, while the Dow
declined by 8% and the S&P 500 by 9%. The unhedged
Gold Bug’s index (HUI) increased by 3%, and the Philadelphia gold and
silver index (XAU) increased by 5%. When the broad-based equity markets
decline, they tend to impact all sectors, including the mining sectors,
regardless of the fundamentals. Because the commodity sectors are small in
terms of market capitalization, any sell-off often can result in much higher
declines.
The Canadian mining stock mutual funds gained an average of 5% since January
2008, whereas The Millennium BullionFund, a mutual
fund that holds physical gold, silver and platinum bullion, rose by 18.9%.
These same disparities can be found in other top commodity producers. In
2007, the world’s largest silver producer, Coeur D’Alene, posted
no gains for the year, although the price of silver increased by 14%.
Year-to-date, Coeur D’Alene is down 1.1%, while silver is up 18%. Exxon
Mobil shares were up 22% in 2007, while oil rose 57%. Year-to-date oil is
down 2.5%, while Exxon is down 11.1%. Cameco, the
world’s largest publicly traded uranium company, was down 1.6% in US
dollars in 2007, while the price of uranium remained flat. Year-to-date Cameco is down 18%, while uranium is down 13%.
In 2007 Barrick Gold posted gains of 38% in US
dollars, largely because they announced a dehedging
program for their producing mines; Newmont Mining rose 8% while gold advanced
31%. Year-to-date gold is up 11%, Barrick 18.6% and
Newmont 4.3%.
Platinum outperforming platinum stocks
A recent example of this lack of correlation is illustrated by South African
platinum mining stocks. Platinum production is highly concentrated; Africa
mines four-fifths of the world’s platinum supply. Anglo Platinum, the
world’s largest platinum producer, rose 21% in US dollars in 2007,
while the price of platinum went up 34%. For the year to date, Anglo’s
shares have increased by 8% in US dollars, while the price of platinum
climbed 25% and reached new highs in excess of US$1,900. The disparity in
performance can be attributed to the many factors influencing profitability,
such as rising energy prices, scarcity of mining equipment, political
instability and labour issues, all of which contribute to rising costs. In
January 2008, many mines in South Africa, including platinum mines, were shut
down for five days because of a nation-wide electricity crisis. The
electricity shortages are expected to continue for 2-3 years, and no new
mining projects will be approved during that time. Clearly, this will have a
negative impact on producing mines, and devastating results for junior miners
that are not yet in production. The price of platinum, however, will continue
to increase due to supply deficits. The 2008 platinum production deficit is
expected to widen to 400,000
ounces compared to the 280,000 ounce
deficit for 2007. Real diversification requires multiple asset classes.
Choosing to invest in bullion or mining stocks is not an either/or decision.
During the current bull market in commodities, the equity portion of the
portfolio should include an overweight position in a variety of commodity
producers, particularly in the energy, food, water and precious metals
sectors. In order to be fully diversified, investors need to include all six
asset classes in their portfolios: stocks, bonds, cash, real estate,
commodities and precious metals. Of these six, precious metals in bullion
form are the most negatively correlated to traditional financial assets such
as stocks and bonds. Holding bullion reduces portfolio volatility and
improves returns during normal market conditions, and will act as portfolio
insurance during periods of economic stress, growing in value and effectively
offsetting losses in the other asset classes. During high inflation periods,
such as the one we are heading into, bullion tends to outperform all other
assets classes. During the 1970s, a memorable period of high inflation,
precious metals outperformed all other assets classes for over eleven years.
While bullion prices are rising, mining stocks can form a significant part of
the equity component of every portfolio. However, a minimum precious metals
allocation of 7% (for a conservative portfolio)and up to 16% (for an
aggressive portfolio) should always be in the form of fully allocated,
segregated and insured bullion, in order to protect portfolios from real
inflation and market declines.
Real wealth preservation
In the March 2006 issue of Financial Analysts Journal, CFA’s David
Hillier, Paul Draper and Robert Faff stated that “Financial portfolios
that contain precious metals perform significantly better than standard
equity portfolios.”
In 2005, a
study by Ibbotson Associates concluded that holding gold, silver and platinum
bullion (7.1% for conservative portfolios, 12.5% for moderate portfolios and
15.7% for aggressive portfolios) could reduce risk and improve returns.
During periods of economic uncertainty or high inflation, allocations should
be higher. Gold and silver have been used as money for over 3,000 years, and
platinum for centuries. Today, the world’s wealthiest families still
hold bullion to protect their wealth. Precious metals have proven to be the
best protection an investor can have against both inflation and monetary
crises. As the financial storm clouds become evident to everyone, any
portfolio without bullion is needlessly at risk.
Nick Barisheff
Bullion
Management Group
Nick Barisheff is
president of Bullion Management Group which manages The Millennium BullionFund. For more information please visit http://www.bmsinc.ca/index.php
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