Consider Gold, SilveR and Miners in your Portfolio For Diversification & Stagflation Protection

One of the most important actions to consider taking heading into stagflation is to add precious metals to a portfolio of financial assets. Gold and silver might pay no interest. However, they compare favourably with cash and bonds which may, in real terms, produce negative returns. Moreover, precious metals also don’t potentially go bankrupt or default, and their prices tend to at least keep up with if not necessarily outperform inflation over time.

As their prices also tend to move somewhat independently of both stocks and bonds, they increase the diversification benefits of a portfolio and stabilise returns. A simple exercise in passive portfolio analysis demonstrates this.

Looking at the past few decades, adding 10-15% precious metals to a portfolio of stocks and bonds reduces the volatility without sacrificing anything in returns. Looking longer term, including the dreaded, stagflationary 1970s and early 1980s, a material precious metals holding would have substantially enhanced returns.

While both gold and silver can be owned outright for minimal storage costs or through an ETF tracker, there is also the option of investing in miners. As these share the pricing-power characteristics of basic industrials generally, they have defensive, essentially inflation-proof properties, and the valuation of the sector at present is not particularly high. (Newmont, the largest US-listed gold miner, has an EV/EBITDA ratio of under 10.)

However, it is only the mature miners with proven resources which tick all of the defensive boxes. They may offer less potential upside than junior firms in the event of a large precious metals bull market, but such is the nature of the risk-return trade-off in precious metals miner investing.

Last year, precious metals performance was disappointing given the context of rising inflation. I consider it possible that the ongoing crypto craze may have provided a headwind for a time. If so, that headwind may now be dissipating as the crypto sector undergoes a correction.

Meanwhile, real interest rates remain deeply negative. Whatever happens in the crypto world, this represents a tailwind for precious metals tailwind which could well prevail over the course of 2022. Moreover, the recent rise in energy prices implies higher input costs for miners. While that might be an issue in a sector without pricing power, precious metals miners can easily pass that on, occupying as they do, a place low on the value chain.

Does Gold Provide Portfolio (and Financial Independence) Insurance

During financial busts, bear markets, crises and crashes, investors tend to flock to gold...

• It’s is a safe haven. Why lose money in other assets when the chances are that gold will go up in value?
  If there is a banking crisis, losses from banks are possible. Gold provides safety from a banking crisis.

• Governments and central banks create or print money out of thin air to cushion a market crash which causes rises in inflation and falls in ‘real’ interest rates…

That means cash in the bank earns less than it did, making gold more attractive. Real interest rates are what you get after deducting inflation. If the banks pay 5% (those were the days) and inflation is 7%, real rates are -2%. If inflation is high and the bank pays you next to nothing, why own cash when you can own gold? 

If you're in the UK two of the biggest and best Gold ETF's are SGLN and PHGP. If you click the links and view the 'Costs' section for these ETF's you will see that SGLN cost of ownership (OCR 0.12%) is lower than PHGP (OCR 0.39%). There are no differences in terms of custody and security. This is simply market forces bringing down prices. PHGP are being complacent by not dropping prices, and many investors are switching to cheaper products. SGLN trades in GBP and is the most liquid Gold ETF on the London market. 

Over the longer term, Silver also sees price appreciation but is more volatile than gold so unless you are trading silver (high risk) the only option is trying to buy low and hold for many many years, ignoring the price action. Any well known Silver ETF similar to the one linked to above should do the job.

The 'Friends of Gold' (... & Silver... & other precious metals)

Wheaton Precious Metals (formerly Silver Wheaton) trades on the New York and Toronto Stock Exchange. The New York listing has the ticker “WPM”.

Companies like Wheaton Precious Metals provide a “half-way house” between the ownership of inert bullion – where the only returns will be through price appreciation of the underlying physical asset – and the ownership of fully-fledged mining companies that may, or may not, be good at capital allocation as opposed to shareholder capital destruction.

It’s worth noting that as with any listed business, especially one involved in commodities markets, there are always risks. The price volatility of Wheaton Precious Metals may well be higher than for a non-commodity-related business.

Because silver constitutes a major part of its revenues, underperformance of the silver price relative to that of gold may lead to underperformance by the Wheaton Precious Metals share price, too. And because it’s a US dollar denominated stock, that clearly gives rise to foreign exchange risk for a UK investor.

Wheaton Precious Metals

In the interests of building a fully diversified precious metals portfolio, streaming companies have a lot to be said for them in theory, but the chart for Wheaton looks a bit volatile to me. But probably not much more so than the 'default' Mining ETF from VanEck that many DIY investors use for diversified access to Gold miners. 

VanEck Gold Mining ETF

The Problem with Gold

Gold can stagnate for long periods when the economic conditions are such that it is just 'out of favour'. 

Gold peaked on 2011 and only broke out of a long secular 'cup and handle' bullish pattern in MAR 2024. Yes... about 13 years later!... 

In the short term and medium term, the price of Gold can be erratic. If you look at the 2022 to 2024 chart below, priced in GBP, of Gold against the MSCI World stocks index, It is actually a pretty strong performance by Gold, holding it's own ober this period with a matching valuation in 2022...

... but when you zoom in during that period to a shorter 5 year period between 2010 and 2015 gold returned about 10% whilst global stocks returned about 80%. If you had bought gold on 2012 and the MSCI in 2012 then gold would be down about 50% whilst stocks would be up 80% ...