My formative years were the 1980s and the 1990s and like many of that generation, I grew up on a steady diet of rock music. In the early 1990s when I was in high school heavy metal bands like Metallica were topping the charts. While bands like Motley Crue, Guns and Roses, and others still occupy my workout playlist, hard rock and heavy metal music has largely become a thing of the past. Conversely, we’ve seen an interest in physical metals explode over the past decade and many portfolios now have material holdings in these assets. The internet and the airwaves are saturated with ads for gold and other assets and breadth and depth of the rally we’ve seen in the metals market is without historical precedent.
Metals markets have occupied front page news. This past Friday, many metals fell precipitously on the back of the announcement of Kevin Warsh as the nominee for Fed Chair. As Warsh is more hawkish (generally in favor of higher rates, tighter monetary policy) than other potential nominees, the US Dollar surged and metals fell. The market seemed to view that the Warsh appointment will result in higher rates (with slower economic growth=>less demand for metals), and less demand for safe haven assets (because the dollar will be more attractive and stable). Silver, for example, had a spectacular one-day drop:
This may be an example of what a colleague refers to as markets “selling first and asking questions later” or a correction in the spectacular run that metals have had over the past several years. Consider what gold, silver, steel and rare earth metals have done over the past 12 months (even with the steep decline on Friday):
Given the deep interest in these assets and recent volatility, I thought it would be interesting to explore metals broadly and the role that these play in modern financial markets and in investor portfolios. We’ll consider the different categories of metals, why they are so popular today, and the potential pros and cons of having these in one’s portfolio.
What are the different types of metals?
When I think about metals, I mentally assign them to different buckets based on their characteristics. When we delineate metals in this way, we can start to assess how they respond to different economic conditions and whether or not a given metals’ specific attributes give us the exposure we’re seeking. While there are many ways to bucket metals, these are the broad categories I think of:
- Industrial metals. These are metals that are more commoditized and have mass commercial application. These are metals that typically are abundantly available and broadly used in many applications. These types of metals correlate with broad economic expansion and growth in specific products and industries. Examples include copper, aluminum, and steel.
- Dual use metals. These are metals that have industrial uses but also have a long tradition as a store of value. This includes metals like gold and silver. For example, gold is used in jewelry and electronics, but through millennia has also been used as a store of value and as a medium of exchange
- Rare earth metals. These are metals that are difficult to extract but have broad usage in commercial and military applications. These have become absolutely indispensable in modern technology and competition for primacy in these metals is fierce. These metals include scandium, europium, and gadolinium to name a few.
Why are metals so popular today?
Metals are popular today for a variety of reasons, but key the reasons I would highlight are the following:
- Perceived safety
- Attractiveness of owning a tangible asset
- Non-correlation to other investment assets
- Inflation hedge
- New demands for these assets in our modern economy
- Ease of ownership
Many metals provide perceived safety based on their historic use as a recognized store of value. Assets like gold are tangible and throughout history have been assigned value based on the combination of relative scarcity and broad acceptance as a medium of exchange. Their degree of safety, however, can be illusory depending on things like current price level and supply and demand dynamics. Gold, for example, can be subject to wide price swings and long periods of time with anemic performance. If one happens to purchase at a sub-optimal time, the price relative to other assets can decline and any feelings of safety can sharply be eroded.
Whether valid or not, many place a high value on tangible assets-those that are able to be seen and touched. There is probably some mental anchoring that all of us have here when we consider how little paper currency can buy today relative to what it could decades ago. We also have the historical record of hyperinflationary situations (like Weimar Germany) where paper or fiat currency lost most of its value.
People also value metals as a minimally correlated/non-correlated asset class. This is perhaps in my mind one of the chief benefits of having some exposure to metals. Non-correlated assets provide portfolios with some potential downside protection when other assets are falling, and in some instances, allow one to partially hedge against specific risks. Consider for example a simple portfolio made out of bonds and US stocks. When we look at the correlation over the past 10 years between these assets, we see a meaningful amount of correlation (for reference “SPY” is US stocks, “AGG” is bonds):
While there are diversification effects with this portfolio to be certain, the positive correlation component means that risk hedging over this time period wasn’t necessarily optimized. As such, the level of diversification over this time period was wanting. Consider, for example, 2022, when stocks and bonds both fell. The high degree of correlation during this year led to steep losses in both stocks and bonds. Contrast this with a portfolio where we add some gold (“GLD” in the below chart) to the equation:
The low level of correlation between gold and stocks and bonds would have aided the portfolio in a year like 2022 when stocks were down 20%, bonds were down about 15%, but gold was down less than 1%. These are rudimentary portfolios but they illustrate the potential benefit of having some assets that don’t correlate with the rest of the portfolio.
Another reason for the popularity of metals is the perceived value as an inflation hedge. While this is conventional wisdom, it doesn’t hold in every circumstance. Reverting to 2022 again, inflation crested at about 9.1%. Gold finished that year down .77% and certainly didn’t keep up with inflation that year. Conversely, gold surged during the high inflation of the 1970s only to crash and stagnate on the back of high interest rates that reined in inflation.
Other reasons for metals’ popularity is broader availability and increased demand for these assets. Innovations like ETFs have enabled investors to own metals electronically (usually backed by the actual metal). This has lowered the cost of ownership and made entry and exit and price transparency extremely easy. Moreover, as the global economy has grown and as much of the world has exited extreme poverty, demand for consumer goods has exploded as has electronic innovation. As metals are the backbone of these products, appetite and interest has expanded.
What are the pros and cons of investing in metals?
One observation we continually make as we analyze investments and research global developments is both greater polarization and less interest in nuance. In our opinion, metals are neither the sole safe space left nor are they something that should be excluded from one’s portfolio. We view metals within a portfolio the same way we would tools in a toolbox. If we have limited space in our toolbox, we only take the best tools. A hammer and screwdriver would be indispensable in such a toolbox, but we would probably squeeze in things like allen wrenches as space permits. From a portfolio construction perspective, stocks and bonds would be our hammer and screwdriver, while metals would be our allen wrenches-an important, but non-essential small peripheral holding.
In terms of the pros and cons of metals in a portfolio, the below table summarizes our thoughts:
| Pros: | Cons |
| A store of value during times of currency debasement | Doesn’t keep up with stocks over time |
| Opportunities for significant short-term gains | Doesn’t pay any dividends or generate earnings |
| A flight to safety asset during times of turmoil | Subject to periods of boom and bust |
| A way to trade on broad economic growth | Subject to extreme price volatility |
We hope this adds to your perspective around metals and, as always, are available to discuss this further as questions arise.
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