Precious metals equity

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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. [1] 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 [2]), for U.S. gold mining stocks from 1965 - 2014. Note that mining stocks have historically possessed moderate correlation with gold bullion; [3] low to negative correlation with the S&P 500 index; and negative correlation with 10 year U.S. treasury bonds. [4]

Table.


(View Google Spreadsheet in browser, then File --> Download as to download the file.)

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. [5].
  • 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. [5]

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. [6]

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. [7][note 1]
  • 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. [8] [9]
  • 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. [10][note 2]

In addition, S&P [11] and MSCI [12] [13] provide indexes of gold and silver mining stocks. Dow Jones provides a Precious Metals Index [14]

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

Table. Precious Metals Equity Index Returns


(View Google Spreadsheet in browser, then File --> Download as to download the file.)

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. [15] 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. [note 3]

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. [16]

ETF Ticker Morningstar Expense Ratio Tracking index
Global X Gold Explorers ETF GLDX link GLDX 0.65% Solactive Global Gold Explorers Index
iShares MSCI Global Gold Miners ETF RING link RING 0.39% MSCI ACWI Select Gold Miners Investable Market Index
iShares MSCI Global Silver Miners ETF SLVP link SLVP 0.39% MSCI ACWI Select Silver Miners Investable Market Index
Market Vectors Gold Miners ETF GDX link[note 4] GDX 0.53% NYSE Arca Gold Miners Index
Market Vectors Junior Gold Miners ETF GDXJ link[note 4] GDXJ 0.55% Market Vectors Global Junior Gold Miners Index
PowerShares Global Gold and Precious Metals Portfolio ETF PSAU link PSAU 0.75% NASDAQ OMX Global Gold and Precious Metals Index

Notes

  1. Historical data can be found at [NYSE Arca Gold BUGS Index (HUI). There is also a short index: NYSE Arca Gold BUGS Short Index (HUISH)
  2. Historical data can be found at NYSE Arca Gold Miners Index (GDM)
  3. The Vanguard Precious Metals & Mining fund is not a suitable option for investing in precious metals equity. In 2004 Vanguard broadened the mandate of the Vanguard Precious Metals fund to include base metal and other materials mining stocks. (See 2004 Annual Report). The move essentially ended the fund's applicability as an allocation in gold equity.
  4. 4.0 4.1 Enable browser cookies to view.

See also

References

  1. definiition, investopedia.
  2. Kenneth R. French data library, the spreadsheet download for 48 Industry Portfolios.
  3. For gold returns, see Historical gold prices for 200 years since 1792, onlygold.
  4. S&P 500 index data and 10 year Treasury Note data comes from Annual Returns on Stock, T.Bonds and T.Bills: 1928 - Current, Damodaran Online
  5. 5.0 5.1 The Longest Discipline, by William J. Bernstein
  6. Craig Rowland and J. M. Lawson, The Permanent Portfolio: Harry Browne's Long-Term Investment Strategy, John Wiley & Sons (2012) ISBN 978-1118288252
  7. HUI, New York Stock Exchange
  8. NASDAQ
  9. Stock prices of indexed companies at kitco.com
  10. GDM, New York Stock Exchange
  11. The S&P Global BMI Gold Index
  12. MSCI ACWI Select Gold Miners IMI factsheet
  13. MSCI ACWI Select Silver Miners IMI factsheet
  14. Dow Jones Precious Metals Fact Sheet
  15. Equity Precious Metals: Total Returns, Morningstar
  16. A Beginner's Guide To Mining Stocks, investopedia, October 11 2012

External links

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