You may have noticed recent headlines extolling the virtues of precious metals in times of elevated inflation expectations. Precious metals do have a place in a well-diversified portfolio since they provide returns that don’t behave exactly like stocks or bonds. At APCM we consider metals an important asset to consider for long-term or short-term asset allocation in the context of a client’s unique circumstances specific goals.
The question is whether the four precious metals – gold, silver, platinum, and palladium – are equally useful regardless of the expected market environment or if certain environments favor one metal over others. I’ll explain, generally, in what types of environments each would be expected to perform their best. The performance of these metals is varied and complex, a deep dive into which is beyond the scope of a blog. So, while the following general environments provide guidance at a high level, actual performance in a specific market environment may vary.
Gold gets the most attention of all the precious metals, particularly in Alaska, and for good reason. It is one of the oldest forms of money in recorded history. Over the very long-term, gold’s price should at least keep pace with inflation, but over short periods the link has been weakening since the end of the Bretton Woods system. There are multiple drivers of gold’s performance including the value of the dollar, equity risk premia, anticipated volatility, and real interest rates to name a few.
In the context of the point of this blog though, I would generally choose gold over the other precious metals if I expected a period of stagflation (high inflation that causes a stagnant economy) in the U.S. when real rates (interest rates after subtracting inflation) are negative. In such an environment, I would expect the dollar to weaken, less negative impact from low growth since industrial demand for gold is a small portion of overall demand, and Treasuries (the other major safe haven asset) to provide me with a loss in buying power since real rates are negative. In that situation, I would turn to gold to be the safest store of value.
Silver is the other precious metal that most people associate with money, but the majority of demand for silver is from industry. Silver is used in a wide array of goods including medical devices, brazing and soldering, and almost any electronic application you can think of. Because so much of demand is industrial-based, I wouldn’t generally recommend silver in times of stagflation, where industrial demand isn’t going to expand or even contract. But, if I were looking at an environment where I expected strong global GDP growth with higher than normal inflation, I would choose silver over gold as an investment. The price of silver generally reacts in the same direction as gold when safe havens are desired in good GDP growth environments, but with greater magnitude.
This is less of a safe haven asset than gold though because of that greater magnitude of price movement. Volatility is higher for silver than it is for gold. But if there is a high probability of strong GDP growth, that volatility would work in your favor.
Platinum and Palladium
I group these two metals together because, like silver, demand is mostly driven by industrial uses, particularly the automobile industry. In that use, platinum and palladium are substitutes for each other as both are used in catalytic converters to reduce pollution from internal combustion engines, particularly diesel engines. Approximately 80% of demand for these metals comes from the auto industry. Platinum does have some demand for minting coins and bars as well as jewelry, while palladium is only rarely used for jewelry and isn’t really used for coins or bars. Given that, both of these metals will likely be greatly influenced by demand for automobiles, particularly in countries with environmental protections and a decent percentage of diesel engines (Europe for example).
Which of the two metals is better will depend on the other. Since they are substitutes for each other, if one metal becomes too expensive, manufacturers switch out to the other. So the choice will depend on each metal’s price relative to the other and the outlook for near-term production.
APCM believes that changes to the strategic asset allocation that was chosen to meet a client’s long-term financial goals should only be adjusted for the near-term modestly. Our focus is to take advantage of temporary dislocations in price to incrementally improve return or reduce risk so as not to derail the carefully constructed and modeled long-term plan. Precious metals can provide a safe haven in uncertain times, but they aren’t always the best option as they tend to experience higher volatility than some other assets. APCM’s advice – use precious metals as safe haven assets in the context of your long-term goals and overall portfolio, and don’t expect them to be driven by a singular return driver like inflation.
Vinay Sharma, CFA®, CIPM®
Senior Portfolio Manager