Smart Money: the case for precious metals beyond gold

Australian Financial Review, September 2011

We all know about gold: it’s hovering around record highs, adopted as a safe haven by investors the world over looking for a place to escape from global market volatility. But what about other precious metals? Australians can also invest in silver, platinum and palladium, but their outlook – and the dynamics that drive their prices – are far less well known here.

Aside from gold, ETF Securities offers exchange-traded funds over silver, platinum, palladium and a basket combining them. While its funds in the less celebrated metals are popular globally – it has holdings worth US$1.8 billion for its global silver ETFs, $1.7 billion platinum and just over $1 billion for palladium – Australians have so far had much less interest in them. The Australian ETFs hold A$75 million for silver, $8 million for platinum and just $2 million for palladium.

Should more investors take a look? First it’s important to understand what drives prices. “Silver is very interesting,” says Danny Laidler, head for Australia at ETF Securities. “It’s 50-50 between being a store of value and industrial usage, whereas gold is predominantly just a store of value asset which goes well when there is volatility in equity markets. So silver has safe haven aspects, like gold, but also offers exposure to economic recovery.” Silver is used in a host of industrial applications, particularly around technology and photovoltaic applications, so any increase in global economic activity is to the benefit of the metal. “Lots of investors are taking a bar-bell approach to recovery: they want to participate in that recovery but are also concerned about risk,” Laidler says. “Taking that approach, silver fits well.”

Silver has, though, had a volatile year. “Earlier this year we saw it go from 30 to 50 [US$ per ounce], and then the margin to invest in silver on the futures market was changed, which caused a reduction in the price,” says Malcolm Smith, Director at BlackRock in London, and in charge of commodity-related portfolios. “Short term movements are quite fitful and it is difficult for investors trying to trade around that. We don’t try to do that: we take a medium to long run view.” His view is positive, although as a fund manager he typically expresses that view through holdings in stocks, particularly in Mexico, which traditionally has dominated silver production. As he points out, the cash cost of production of silver is around $10 to 15, so with silver trading at around $40 per ounce (US$40.58 at the time of writing), they’re making good money.

Platinum and palladium are both vital for automobile production, and specifically the catalytic converters used to reduce vehicle emissions; catalysts in diesel engines usually use platinum, and gasoline engines palladium. Platinum also has a certain precious-metal allure to it – it’s 15 times rarer than gold. Both are particularly concentrated in certain markets: Smith says South Africa is responsible for 75% of world platinum supply, and Russia for much of the rest, while much of the world’s palladium (how much is a debated point) is held in stockpiles in Russia. Smith says platinum in particular, with the uncertainty of supply that comes from one dominant market in Africa, is susceptible to supply issues, which in turn impacts the cost of the metal. Laidler adds that some people buy these metals “to get exposure to BRIC markets,” but notes that the biggest impact in recent months has actually been the earthquake in Japan, since so much automotive production is handled there.

Whatever the drivers, the metals do offer diversification, lacking an obvious correlation to other asset classes. They all tend to perform well during periods of inflation and so, like gold, are commonly used as a hedge against that.

Australians appear to be beginning to show some interest: Laidler says half of the inflows into the silver product have taken place in the last six months or so.

Apart from ETFs, Australians can buy equities exposed to these metals. Australia hosts one of the largest silver mines in Cannington, run by BHP Billiton, although clearly buying BHP gives exposure to a lot more than silver. Pure-play silver miners are more frequently Latin American. Seeking platinum exposure through stocks really requires investing in South African equities, which may be beyond many investors’ risk profile.

It’s also possible to buy silver through the Perth Mint, which sells a wide range of coins and bars in silver, and also offers depositary and storage services. These coins and bars are valued according to spot market prices and there is a ready and liquid market for them.

Also, from next month, a new option will enter the market. On October 4, the Australian Bullion Exchange (ABX), the first physical bullion exchange in Australia, will open its doors.

Similar to the UK’s London Bullion Market Association, the ABX will not immediately be something where retail investors can log in and buy and sell; it is instead an over-the-counter market that seeks to connect buyers and sellers, with that buying and selling only conducted through approved brokers called members. ABX won’t be setting prices in its own right – it will go off international spot prices – but aims to provide “a large liquid market that has not existed in Australia before now,” according to Thomas Coughlin, CEO of the new Brisbane-based exchange. Initially the market will offer gold, silver and platinum bullion, and will offer custodian and storage services as well, with metals secured in a Brisbane vault.

Where this will be relevant to retail investors, Coughlin says, is that “by launching a centralised market, what we’re intending to do is foster competition, which should lead to increased cost effectiveness and accessibility. Our view is that costs in the physical bullion industry in Australia are way too high.” The market’s first phase will link brokers, financial advisors and other institutions; it’s in the planned phase two, a programme called ABX Connect that will link up to trading platforms, that this will probably have greater impact to Smart Money readers. ABX appears a small enterprise at first, launched by a fund manager, an accountant and a lawyer and with just three members of the board at launch (floor members will be offered directorships along the way); but it will be interesting to see how it is used and what investment products come off the back of it.