If the price of metals gets too high, markets contract or users find substitutes—aluminum for steel, PVC for copper piping. But some metals are rare enough, and their applications specific enough, that substitution is difficult.
Gold and silver are the quintessential hard-to-replace commodities. Platinum and palladium, though used industrially, are increasingly regarded as precious metals. Rare earths—which aren’t all that rare, just hard to mine economically—make up components for iPhones and plasma TVs, and are plays on the future.
Gold, out of favour through most of the 1990s, grew in popularity in the early 2000s as the Bush administration pursued a weak-dollar strategy for the U.S.
Mark Serdan, portfolio manager of the BMO Precious Metals Fund, says other factors included “the debt crisis in Europe and inflation concerns. Investment demand was also strong during that period, driven by a lot of those factors. There was a lot of central bank buying, especially out of India, China, Sri Lanka, Venezuela and other smaller countries.”
Supplies also were in decline at that time. “And then,” Serdan says, “you saw that parabolic move in gold in the summer of 2011 when you had the blowout of the European debt crisis.”
While gold’s been prized more as a safe-haven asset than an industrial commodity, investors have traditionally gained exposure through mining companies rather than buying the metal outright. That’s changing as more gold and silver ETFs come to market; even the Royal Canadian Mint has jumped into the fray (see “Royal ETRs,” this page).
Still, the advantages to owning mining companies should be that the cost of extraction and refining must be lower than the metal’s price, says Serdan. But “the biggest, large-cap gold miners haven’t proven that through the cycle. They’ve shown poor returns and you haven’t seen that leverage in margins. You should see with the rising gold price,” he says. “Unfortunately over the past three years, miners have shown poor decision-making in imposing capital discipline, and that’s worked against them.”
He does have some bullion-like holdings: gold certificates. His top holding is Bank of Nova Scotia certificates. Like gold receipts, they permit the owner to accept physical delivery of bullion. But they are bank obligations, just like GICs. Unlike GICs, however, they’re not easily cashable. Investors must accept delivery at 400 ounces per bar, or face additional charges.
“But certificates themselves remain easily tradeable, and avoid the assay, shipping, insurance and storage costs associated with bullion,” Serdan says. “They can be bought in denominations as low as 10 ounces.”
He’ll choose certificates over mining stocks because “sometimes you’re not seeing the [performance] out of the companies that you want to see, so you’re adding a bit of safety,” he says. “And I’ve always viewed it as an alternative source of cash [that allows me to gain] exposure to the gold price.”
All that glitters isn’t gold
David Franklin, market strategist at Sprott Asset Management, spoke at the World Resource Investment Conference in May 2013. He said many investors tell him, “I don’t get gold. It doesn’t do anything. Industrial use is only 10%.” For these investors, he says that platinum and palladium are appropriate investments, since the metals are primarily used industrially.
The two metals naturally occur together, with most deposits in South Africa and Russia, and their chief use is automobile production. Platinum trades at twice the price of palladium, and is used as a catalytic element in both diesel and gasoline engines to help reduce fuel emissions and meet regulatory standards. Manufacturers use palladium for the same purpose in gasoline motors only.
Franklin says, “You can follow the use of platinum and palladium in the headlines by following auto sales.” Thanks to demand, auto production is up in the U.S. and China (see “Take advantage,” page 7), but down 20% in Germany because the strong euro is denting affordability for those makes.
There also are shortages; strikes in South Africa have led to a deficit of 1 million ounces of platinum from normal annual production of 8 million ounces. The likelihood of more strikes means the shortage is likely to persist. Workers want a 60% wage increase, and wage costs account for 70% of total mining costs. And those costs are becoming prohibitive. The cost of mining for Implats, the second-largest miner in South Africa, is $1,766 per ounce of platinum versus the June 2013 price of $1,431.
“A rational executive would say, ‘We’re going to shut this mine down. We’re losing money on every ounce produced.’ It is a highly, highly volatile situation,” Franklin says. The miners are not earning their cost of capital. So he would opt for the physical metal, especially because a shortage will drive its price up, providing auto production holds in Europe.
Looking beyond China
Rare earths are a different story. Around 95% of production is in China and that country imposed more stringent export quotas in 2010, causing prices to spike. As a result, says Jon Hykawy, head of Global Research at Byron Capital Markets in Toronto, many users have gone in search of substitutes.
“It was nine months before demand collapsed and prices started to come back down,” he notes. “No one wants to get caught in that situation again, so they’re waiting for the Molycorps and the Lynases of the world to come to production.” Molycorp is opening a mine in Californa; Lynas, one in Australia. But progress has been slow. When those mines start operating, “they’re going to get prices that are much closer to historical norms but they’re also going to [provide] a supply chain that’s independent of China. That’s a big selling point to a lot of companies.”
But there’s only room for four or five producers. Opening a mine in Canada has been tough, despite the fact that all rare earths exist here, and the doldrums of junior resource companies haven’t helped.
“There’s little interest in resource names [and] exploration names in particular; rare earths are regarded as having had their time,” Hykawy says. “Yet on the heavier rare earth side I see interesting names: Matamec Explorations, with a deposit in Quebec, and UCore Rare Metals, which has a mine in Alaska. They would satisfy that security-of-supply-chain requirement.” (Heavier rare earths, such as terbium and dysprosium, are used in phosphors for efficient lighting and high-powered magnets.)
Investor demand and fundamentals
Economist Nouriel Roubini has predicted gold will drop to $1,000 an ounce—a far cry from its heights of $1,900 during the European debt crisis, and current trading level of $1,400.
But some analysts don’t think the metal’s fundamentals have changed.
“In the last six months we had a drop off,” says Mark Serdan, portfolio manager for the BMO Precious
He adds, “I wouldn’t say the big factors that were driving [gold’s price rise] have run their course.”
While the U.S. dollar has strengthened, “the U.S. continues to run an annual deficit of a trillion dollars and their aggregate debt is $16 trillion—and growing by a trillion a year.”
Serdan also points to the simmering European crisis.
Silver rounds out the conventional repertoire of precious metals investing, but has a wider industrial use than gold. Still, says Serdan, “I look at silver as a derivative of gold. Silver trades similarly.”
Against that, David Franklin, market strategist at Sprott Asset Management, pointed out at the 2013 World Resource Investment Conference that the biggest increase in platinum demand in the first half of 2013 has been in clients buying coins and ETFs.
The SPDR Gold Trust ETF is down 17%. But ETF Securities’ platinum ETF was up 30% and its palladium ETF was up almost 20% over the last six months.
While that may reflect a rotation out of gold and silver, it also reflects the availability of some new investment vehicles.
South African firm Absa Capital (an affiliate of Barclays) launched a platinum ETF that within a month held 400,000 ounces—the annual demand predicted by analysts.
As for gold and silver, Franklin agrees that recent price drops are driven more by market factors than fundamentals.