Everything you need to know about precious metals

Precious metals such as gold and silver have long symbolised wealth across the world. While such commodities can be used for long-term investment, they also present some excellent trading opportunities.

Ancient Egyptians made jewellery from gold well before it eventually came to be used as a currency by the Romans.

The British pound has its origins in Anglo-Saxon England when it was equivalent to a pound of silver.

Along with making jewellery and other adornments and luxury goods, and being viewed as store of value, these days precious metals have very many industrial applications. Palladium and platinum are synonymous with the auto sector given their use in catalytic converters.

Gold bars in storage.

While precious metals such as gold continue to be used for long-term investment, they also present some excellent trading opportunities. For instance, contracts for difference (CFDs) allow investors to potentially profit from down moves as well as up moves in prices on any given trading day.

Other means to invest in precious metals include other derivatives such as ETFs, the shares of mining companies and bullion. However, the latter route would mean going to the trouble of storing physical coins or bars.

Precious metals trading

Precious metals are traded in exchanges across the world. In the US, gold, silver, platinum and palladium are traded on the New York Mercantile Exchange.

In Asia, precious metals trading takes place on a variety exchanges, especially in India, China and Japan.

While being synonymous with industrials metals trading, last year the London Metals Exchange (LME) also moved into precious metals trading, launching contracts in gold and silver.

In the UK, precious metals trading in gold and silver had traditionally taken place among members of the London Bullion Market Association (LBMA) on an over-the-counter basis, which means directly between two parties and not via a regulated exchange.

Meanwhile, trading in platinum and palladium takes place between members of the London Platinum and Palladium Market (LPPM) association.

However, as precious metals trading happens all over the world, it´s possible for investors to trade in commodities such as gold via online platforms 24 hours a day. These markets only really go to sleep at the weekends.

London Metals Exchange trading ring.

Gold

Gold has both demand and scarcity on its side; the value of gold has long been linked to its rarity, appearance, malleability, strength and resistance to corrosion.

These traits have helped make gold a natural store of value throughout history, given its use in jewellery and other adornments and as a means of payment.

According to the World Gold Council, if every single ounce of gold that was ever mined was in the same place, the resulting cube of pure gold would only measure around 21 metres on each side.

It reckons a total of around 187,200 tonnes of the yellow stuff have been mined since the dawn of time, with around 2,500 to 3000 tonnes continually mined each year.

To put this into perspective, about 475 million tonnes of iron ore are mined each year.

Gold being weighed.

Demand for precious metals trading

Jewellery remains the biggest source of demand for gold, followed by investment.

At the same time, the rise of computer technology has also seen gold increasingly used by the electronics sector given its high degree of electrical conductivity and its excellent resistance to corrosion, as well as to many other chemical reactions.

The circuit boards of everyday items such as laptops, tablets and smartphones contain various precious metals. A standard laptop has been estimated to contain around £25 worth of gold.

Gold has also long been used in dentistry, though this pales in comparison to the current demand related to electronics.

A laptop circuit board.

Gold standard

In the 19th century, the so-called gold standard increasingly emerged, with most countries printing currencies that were supported by a fixed gold value.

Nations sought to hold sufficient quantities of gold to support the value of their currencies so that people could exchange a fixed amount of gold for a given paper currency if they so wished.

It wasn´t until 1976 that the International Monetary Fund (IMF) established a permanent system of floating exchange rates and the gold standard completely disappeared.

Despite having long since abandoned the gold standard, major central banks still retain significant reserves of gold given the metal´s tendency to hold its value during difficult times.

The UK chose to sell about half its gold reserves between July 1999 to March 2002, arguing that it made sense to diversify the Bank of England´s asset reserves in favour of foreign currencies such as the euro, thereby theoretically reducing the volatility of its overall reserves.

However, the then Chancellor, Gordon Brown, subsequently came under fierce criticism for the move as the sales were made at a time when gold prices were at a 20-year low – coining the phrase Brown’s Bottom.

The UK sold 395 tonnes of gold in 17 auctions for a total of $3.5bn. That would have been worth about $18bn at the start of 2018.

Gordon Brown.

Gold prices

Gold is renowned for its ability to preserve wealth over the long term. This does not mean, however, that its price will always rise steadily.

Gold has been known to move up sharply, especially at times of increased volatility and uncertainty. Similarly, during times of relative stability, when risk assets have made strong progress, gold has been known to sell off.

In inflation-adjusted terms, the yellow metal has risen from around $350 per ounce in January 1918 to around $1300 per ounce by 2018, an inflation-adjusted return of just over 270% over 100 years.

This may not appear such a spectacular return compared with something like Bitcoin, which has risen by over 1,200% over the year.

While there is arguably less risk and volatility involved with investing in gold compared with Bitcoin, there have also been some big peaks and troughs in gold prices over the years, and some excellent opportunities for investors to make profits from the moves.

Inflation-adjusted gold prices over 100 years. Source: macrotrends

Wall Street crash

In the aftermath of the Wall Street crash of 1929 and the onset of the Great Depression, gold rose from around $300 per ounce to peak at around $650 per ounce in inflation-adjusted terms in 1934.

During the Great Depression, many Americans began converting their paper dollars into gold and generally hoarding the yellow metal.

However, in 1934, the US Congress passed the Gold Reserve Act, which put an end to this practice as it outlawed the private ownership of gold in the US and forced people to sell their gold back to the Federal Reserve (Fed).

In inflation-adjusted terms, the price of gold subsequently fell from $650 per ounce in March 1934 to just under $240 by March 1971.

Under the 1944 Bretton Woods agreement, the US dollar became the official global reserve currency, pegged to the price of gold at a nominal price of $35 per ounce. The agreement enabled other global central banks to exchange their dollars for gold with the Fed at that price.

The deregulation of gold began in 1971 when US President Nixon halted the conversion of dollars for gold at $35 per ounce. In 1975, Americans were allowed to hold unlimited amounts of gold once again.

Gold shot up over the following years, rising from around $235 at the beginning of 1971 to around $757 per ounce by December 1978 (both in inflation-adjusted terms).

Representatives from 28 allied nations meet to sign the Bretton Woods agreement in 1945.

Gold´s rise

The Oil Shock that resulted from the 1979 Iranian revolution and the outbreak of the Soviet-Afghan war saw gold prices surge further as uncertainty prompted investors to seek out safe havens.

A fall in oil output and the rising price of oil also meant that global inflation picked up, so investors were looking for traditional stores of value rather than leaving the value of their money to erode in paper currencies. US inflation was at around 14%.

By January 1980, gold prices had reached an inflation-adjusted high of around $2,150.

With risk appetite returning and the bear conditions across equity markets abating, gold fell back to around $800 by June 1982.

Gold subsequently reached an inflation-adjusted low of $363 in April 2001 as stock markets surged to record highs during the dotcom bubble.

The end of the dotcom bubble, the 9-11 atrocity and the onset of recession sent gold up once again, beginning a 9-year bull market for the yellow metal.

As in the Great Depression some eighty years earlier, the extreme uncertainty of the recent financial crisis saw gold soar, with the yellow metal rising from $832 in October 2008 to reach a high of $1987 in August 2011, just shy of the inflation-adjusted peak reached in 1980.

The familiar story repeats itself; as volatility has decreased and risk appetite has returned to global markets, gold has tended to sell off.

US dollar strength in 2014 and 2015 was also a factor behind gold´s decline to $1,115 an ounce in December 2015.

Recent weakness in the dollar has helped gold recover to trade around the $1,300 per ounce mark.

On a day-to-day basis, gold tends to move inversely to the dollar, the currency that it is priced in. However, geopolitical worries, such as those related to last year´s North Korea missile and nuclear tests are likely to support gold over the next few years.

This point was affirmed in a recent research note from analysts at Citibank.

“Even as the rates and forex channel dominate the outlook for gold pricing, the yellow metal is increasingly being used by investors as a policy and tail-risk hedge," said the Citi analysts.

Silver

Sliver prices tend to be much more volatile than gold. For one, sliver´s use in industrial applications is much greater than that of gold; industry accounts for around 50% of the demand for sliver as opposed to just 10% for gold.

While less scarce than gold, the price of silver is also much lower, at $17.25 per ounce.

But the relative scarcity of gold versus silver does not appear to justify this massive price gap.

Gold is some 75 times more expensive than sliver, though there is estimated to be just around 19 times more silver than gold in the earth´s crust. The annual ratio of sliver to gold mined is typically about nine times.

This could indicate that either gold is overvalued or sliver is undervalued, or a combination of both.

Silver coins and bars.

Silver demand

Jewellery and silverware account for around 25% of demand for silver compared with the 50% of all demand that jewellery represents for gold, the yellow metal´s principal usage.

Unlike gold, however, pure silver is relatively soft so the jewellery industry tends to create silver alloys, using metals such as copper.

So-called sterling silver, the jewellery standard across the world, has 7.5% copper content.

Nevertheless, much more important to silver demand is the industrial usage of the white metal. Given its status as the best thermal and electrical conductor in the metals universe, the industrial applications of sliver in the digital age are vast.

Silver is used in electronics, solar panels, batteries, nanotechnology, radio frequency technology and medical equipment, to name just a small selection of its vast industrial applications.

There are small amounts of silver in your smartphone and your laptop, in the windows and mirrors of the room you are sitting in, and possibly even in the clothes you are wearing, as engineered silver can be used to neutralise odour causing bacteria in socks and sports clothing.

The remaining 25% of all demand for silver is accounted for by investment demand, as like gold it is also viewed as a store of value.

Solar panels.

Silver prices

In common with gold, silver prices have been known to shoot up at times of extreme uncertainty and risk aversion as investors seek out safe havens.

The highest ever price for silver came at the same time as that for gold, in January 1980. Silver reached an inflation-adjusted high of $111.87 per ounce, a 460% rise from where it stood just a year earlier.

While this was a time of uncertainty and risk aversion, investors also turned to traditional stores of value to protect themselves from soaring inflation.

Along with gold, the year 2001 was also a low point for sliver, with the white stuff trading below $6 per ounce in inflation-adjusted terms. Investor risk appetite was redolent as global stock markets reached new highs and inflation was relatively subdued.

Historical silver prices in inflation-adjusted terms. Source: macrotrends

Silver outlook

As with most commodities, the price of silver is driven by the interaction of supply and demand as well as speculation.

Given its higher relative importance, the industry side of the equation tends to have a much bigger bearing on its price than in the case of gold.

There are times, however, as in 1980, when the investment side of the equation can seem a lot more pervasive in setting the market price.

Known for its higher volatility versus gold, silver markets are also less liquid.

In its 2018 Commodity Outlook, TD Securities tips silver to outperform and close some of its valuation gap with gold.

“Considering silver's traditionally higher volatility and strength during periods in which investors are positive on gold, silver should outperform. Improved industrial activity and weaker mine supply should also help,” says TD.

Platinum

Platinum is an extremely rare, shiny, white metal. If all the platinum ever mined was put in one place, it would only fill a space measuring 25 cubic metres in volume. That’s a cube with side shorter than three metres.

Its value is mainly related to its scarcity and chemical characteristics, though it is also used in the jewellery industry due to its appearance and high resistance to general wear and tear.

The mining of platinum is concentrated, with most of the world´s supply coming from South Africa, followed by Russia and Columbia.

Platinum bars.

Platinum is just as resistant to corrosion as gold, as well as being ductile and malleable, making it suitable for a wide range of industrial applications. Industry represents by far the biggest source of demand for the white metal.

Its chemical characteristics have made it especially attractive for use in the catalytic converters of diesel vehicles, which account for 50% of the annual demand for platinum just on their own. The reason for this is that platinum is effective in oxidising carbon monoxide and hydrocarbons.

Platinum prices

While silver prices are considered volatile, platinum prices are more volatile still, often tending to be the most erratic of all the precious metals traded on commodity exchanges. Both its main sources of demand and supply are highly concentrated.

Over much of history, platinum has been more expensive than gold, so on that basis, at the current price of $975.10 per ounce, it would appear to be historically cheap at present.

On the standard platinum to gold price ratio basis, platinum is at the cheapest level versus gold than it has been for many years.

While there is no guarantee of success, precious metals investors have traditionally viewed times when platinum is trading below gold as a buying opportunity for the white metal.

Historical platinum prices. Source: macrotrends

Cheap

So, why is platinum so cheap at present?

Platinum prices took a big hit in 2008 amid worries over global economic slowdown and the associated falling industrial demand.

Platinum fell from a peak of $2,182 per ounce in May 2008 to hit a low of just $778 in October of that year.

While platinum subsequently recovered to $1,812 per ounce in August 2011, when it traded slightly above gold, the price then traded in a fairly narrow range over the next few years, before falling sharply in 2015 to reach a low of just $879 per ounce in November of that year. The price has recovered relatively little since then.

Given platinum´s extensive use in catalytic converters, especially for diesel vehicles, the Volkswagen emissions scandal that came to light in 2015 has been particularly damaging for the metal.

A Volkswagen dealership.

News that Volkswagen had deliberately misled the authorities over the level of emissions from its diesel cars was seen as a pivotal moment in turning world opinion against diesel engines in general.

Since then, and especially in 2017, platinum prices have also been held down by rising expectations surrounding the rapid take up of electric cars and the general excitement around electric car technology, which is viewed by many as further undermining one of the biggest industrial demand sources for platinum.

Palladium

Like platinum, palladium is a rare, shiny white metal. While both the supply and demand of platinum are highly concentrated, this is also true for palladium.

Industrial usage is even more dominant than for platinum, with the automotive sector alone accounting for well over half of the annual demand for palladium.

At the same time, there is also demand for palladium from the electronics industry as it is found in the majority of microprocessors and printed circuit boards, an important source of demand given the proliferation of smartphones over recent years.

While the single biggest demand source for palladium is in catalytic converters, it is favoured for use with petrol vehicles, in contrast to platinum which is predominantly used in diesel vehicles.

Palladium bars.

Russia and South Africa account for around 80% of all palladium mining, making supply highly dependent on a handful of mines.

However, recycling has also played an increasingly important role in palladium supply.

Palladium prices

Palladium is currently trading near all-time highs, at $1,102 per ounce. A combination of rising demand and tight supply has pushed palladium prices up over recent years.

During 2017, palladium prices overtook platinum prices for the first time since 2001. Palladium has enjoyed a steady rise since reaching a low of around $172 in December 2008 when economic worries hit the demand outlook.

Historical palladium prices. Source: macrotrends

Its use in the catalytic converters of petrol driven cars has been a big plus as it has benefited from the Volkswagen emissions rigging scandal of 2015 as the demand outlook for petrol versus diesel vehicles has bene boosted.

Palladium is also viewed as benefitting from growth in hybrid electric vehicles as these require petrol catalytic converters.

However, TD Securities warns of one potential hazard for palladium on the horizon. The sheer high level of prices means the auto industry may attempt to substitute towards platinum.

“This could include the re-engineering of diesel engines to emit less of the offending gases and the substitution away from palladium and towards platinum loadings in pollution control systems used in gasoline powered vehicles. Indeed, it is our understanding that industrial users who are concerned about the cost and stability of palladium supply are already doing this aggressively — reducing temperatures and oxygen in diesel engines and using different designs to intensify platinum use in catalysts. Substitution away from palladium and into platinum is likely a required strategy for auto manufacturers,” says TD.

Miners looking for silver in Bolivia.

Big miners and streaming names

One way to take a position on precious metals is through the shares of mining or streaming companies. The latter look to profit by making agreements with mining firms to purchase all or part of their output at a low, predetermined price.

Barrick Gold is the largest gold miner in the world, listed on both the Toronto and New York stock exchanges. Its core mining assets are in the US, Peru, the Dominican Republic and Argentina though it has smaller gold mining operations scattered across Canada, Papua New Guinea and Australia.

It also mines copper in Chile, Zambia and Saudi Arabia. The company reported a net loss of $11m in the third quarter of 2017 with adjusted earnings of $186m on gold production of 1.243 million ounces.

A Barrick Gold mine in Nevada.

Goldcorp is another Canada-headquartered gold miner, listed on both the Toronto and New York stock exchanges. Its mines are concentrated in Canada but are also found across Latin America. In the third quarter of 2017, Goldcorp reported earnings of $111m on gold production of 633,000 ounces.

Randgold Resources is a gold miner listed on NASDAQ and the London stock exchange, with its headquarters in Jersey and mining operations focused on West and Central Africa. Randgold reported profit of $60.25m for the third quarter of 2017 on 311,000 ounces of gold production.

First Majestic Silver is a Canada-headquartered silver miner listed on the Toronto, New York and Frankfurt stock exchanges, with its mining operations focused on Mexico. In the third quarter of 2017, the company reported a loss of $1.32m on 2.4 million ounces of silver production.

A First Majestic Silver mine in Mexico.

Pan American Silver is a Canada-based silver miner, listed on the Toronto stock exchange, with its operations focused on sites across Latin America. Pan American reported earnings of $17.8m in the third quarter of 2017 on 5.89 million ounces of silver production.

Wheaton Precious Metals is the largest pure precious metals streaming company in the world, based in Canada and listed on the Toronto, New York and Frankfurt stock exchanges.

The Company has entered into agreements to purchase the silver and/or gold production from high-quality mines for an upfront payment and an additional payment upon delivery of the precious metal. As its operating costs tend to be fixed, Wheaton claims to offer shareholders the prospect of strong margin growth during times when silver and gold prices are on the rise.

Wheaton reported earnings of $66.6m in the third quarter of 2017, selling 82,548 ounces of gold and 5,758 ounces of silver.

Platinum miners in Zimbabwe.

Anglo American Platinum is a South Africa-based miner and the world´s largest producer of platinum, accounting for around 40% of global production. It is also the world´s second largest producer of palladium.

The Johannesburg-listed company reported earnings for the first half of 2017 of R0.7bn ($60m) on 1.19 million ounces of platinum production. Palladium output amounted to 726,000 tonnes in the quarter.

Nornickel is the world´s largest producer of palladium. It is based in Russia and listed on both the Moscow and London stock exchanges. Along with palladium it is also known for its nickel and copper mining operations. Nornickel´s palladium assets are concentrated in Russia.

The company reported profit of $915m for the first six months of 2017.

Opportunities

The sharp price movements and broad range of derivative contracts available through metal trading platforms, offer substantial opportunities for investors to gain from both price rises and falls in precious metals.

Online trading means that investing in precious metals, such as gold, is no longer the preserve of just institutional investors or the very wealthy.

As well as trading in futures, options, CFDs and ETFs linked to the underlying precious metals, investors can also seek to profit from price movements by trading in certain mining or streaming stocks.