What is risk? – Precious Metals
In this series of articles we are considering the different TYPES of RISK we take when investing in different assets.
All that shines. Many metals and jewels make pretty attractive investments in various ways but each has their own risk factors. When buying into metals decide whether you are buying as a pure investment or as a usable investment as this will affect performance and risk.
The main ways to buy into metal and jewel prices are:
Direct – bullion, coins, jewellery etc. Even within this sector the choice is huge. If you want pure investment then buy as close to the raw materials as you can… there are many different mints of coins but some are as collectables and some as investment.
Indirect – this is an exposure to the price of the underlying metal. Many people buy into precious metals via Exchange Traded Funds (ETFs) but wary of some of them.
So what risks are you taking by investing in the shiny stuff?
Asset risk: – the prices of these assets and therefore the value of your holding can be hugely affected by global political/economic events (e.g. Quantative Easing) as well as the fundamentals of supply and demand.
Theft/security risk: – If you decide to buy directly then you must consider the security of your coins or bullion and you need to take that cost into account – you probably don’t want to have $10,000 worth of gold coins under your mattress.
Liquidity Risk: – Selling directly held coins can take time, normally if they are highly traded newly minted then liquidity should be good but collectable coins could take time to find a buyer, or suffer a price fall.
Fashion risk: – Collectable coins/ jewelry are fashion sensitive and not directly linked to the price of the material they are made from. Be careful, they normally trade at a big discount or premium to the underlying material.
ETF: real or synthetic: – Some ETFs buy the underlying commodity and hold it in trust for the investors in the ETF. If you sell your holding, generally, the ETF will sell the actual metal. Other ETFs use rolling “forward contracts” or other derivatives on the underlying commodity via an investment bank. This means that most of the time the price will move with the underlying metal price; but not always – this was seen recently with the ‘paper’ gold price falling dramatically but the real gold price continued to trade above the paper price.
Counterparty risk: – Synthetic ETFs are collateralized by an investment bank; if this collateral is of low quality (very possible) then you may risk the bank being unable to return money if something goes wrong.
Generally precious metals held directly or indirectly (through a real asset ETF) are excellent additions as a small proportion of a portfolio. We have seen huge volatility in prices in the last couple of years and so we must not be over exposed to metals and stay aware of the above risks. Also, like all investments, have a strict profit taking discipline when the values look good.
This article is for information only and should not be considered as advice.
This article is written by Peter Brooke The Spectrum IFA Group