Precious metals equity

Precious metals equity is a term used to define a company that is involved in the exploration or production of a precious metal. Common precious metals include gold, silver, platinum, iridium, rhodium, and palladium. Some investors prefer using gold mining stocks as a substitute for gold bullion in an investment portfolio, and use a mutual fund or exchange traded fund that invests in gold mining stocks. The precious metal mining industry is a global industry; so the funds that invest in precious metals equity are global funds.

Risks
Precious metal mining stocks are subject to a number of risks. These risks include:


 * Market risk: Mining stocks are subject to the forces that affect the overall stock market.
 * Concentration risk: Mining stocks are a small subsector of the market, and are affected by the economic and political forces that can affect precious metals and precious metal mining companies.
 * Currency risk: For U.S. investors, the returns realized from foreign mining companies are subject to the rise and fall of currency exchange rates.

Mining stocks also are quite volatile. The table below provides CRSP data for long term returns (courtesy of Ken French, for U.S. gold mining stocks from 1965 - 2012. Note that mining stocks have historically possessed moderate correlation with gold bullion; low to negative correlation with the S&P 500 index; and negative correlation with 10 year U.S. treasury bonds.

Role in a portfolio
The following arguments support the inclusion of precious metal (gold) mining stocks in an investment portfolio.
 * Unlike gold bullion, mining stocks produce economic value by profiting from the extraction and processing of metals. Shareholder's receive this value through the distribution of profits via dividends.
 * Precious metal mining stocks have historically realized low correlations to the broad U.S. stock market and the U.S. treasury bond market (see table above). In addition, precious metal mining stocks historically have been volatile. While the returns of precious metals equity have been lower than the broad market, the characteristics of low correlation and high volatility are features which provide for positive returns for a rebalanced portfolio. William Bernstein finds that disciplined rebalancing precious metals equity has historically added a five percent bonus to precious metals equity returns..
 * Bernstein also notes that precious metals equity requires a very long investment horizon, as returns of this sector can have very long periods of poor performance.

Investors who include gold bullion in asset class selection usually do not consider precious metals equity as a suitable replacement for bullion in a portfolio. In this view, commodity gold provides an insurance function against disorder in currency, equity, and bond markets that precious metals mining stocks, as stocks, cannot reliably provide.

Precious metals equity and Gold stock indexes
Commonly sited indexes of gold stocks include the NYSE Arca Gold BUGS Index, the Philadelphia Gold and Silver Index, and the NYSE Arca Gold Miners Index.


 * NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The HUI Index was developed with a base value of 200.00 as of March 15, 1996.
 * Philadelphia Gold and Silver Index (XUA) is a capitalization-weighted index composed of 16 companies involved in the gold and silver mining industry. XAU was set to an initial value of 100 in January 1979.
 * NYSE Arca Gold Miners Index (GDM) is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver. The Index divisor was initially determined to yield a benchmark value of 500.00 at the close of trading on December 20, 2002.

In addition, S&P and MSCI provide indexes of gold and silver mining stocks. Dow Jones provides a Precious Metals Index

The table below provides index return data for the indexes tracked by exchange traded index funds.

Mutual funds
The U.S. mutual fund universe contains a sizable number of gold and precious metals funds, all of which are actively managed funds, and many which are broker-distributed load funds. Morningstar tracks performance of these funds. Active funds add to the risks inherent in investing in precious metals funds by introducing manager risk, the chance that poor security selection will cause the fund to underperform relevant benchmarks or other funds with a similar investment objective.

Exchange traded funds
In the U.S. indexed portfolios containing gold and silver mining companies are offered by Van Eck Global (fund inception 05/16/06), Powershares (fund inception 09/18/2008), Global X (fund inception 11/03/2010) and Blackrock iShares (fund inception 01/31/2012).

Note that the Global X Gold Explorers ETF and the Market Vectors Junior Gold Miners ETF track "junior" gold mining stock indexes. Junior gold mining stocks are small speculative companies that are engaged in finding gold deposits. If exploitable deposits are found, these deposits, or the company itself, is usually sold to an established "major" gold mining company.

Articles

 * Rediscovering Gold As An Asset Class Juan Carlos Artigas, Journal of Indexing, November/December 2010.
 * The Expected Return of Precious Metals Equity, by William J. Bernstein
 * What is the Expected Return of Precious Metals Equity? Part II, by William J. Bernstein
 * The Longest Discipline, by William J. Bernstein