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28 January 2015

Passive Investment? Mmmm...



Market action so far this month has been more than many (frankly, including me) might have expected for the whole of the year. While the continued slump in oil prices may have been expected, the violence of currency moves caused by the end of the Swiss Franc/Euro peg was probably not, neither was the concerted attack on copper, led, it seems, by Chinese funds. Add to that the politics of the ECB launching its programme of QE and the uncertainty caused by the Greek election and we have what looks like a recipe for ongoing price instability. Well, for traders and speculators, volatility is broadly a good thing - more opportunities for profit (because, of course, we’re all so good at it we don’t have to think or worry about the other side of that coin…or…?). For the producers and consumers, though, such volatility is perhaps not quite so attractive; what they want is a stable, consistent market to enable them to operate their hedging strategies. 

Periodic Table of Returns

I came across a fascinating piece of research from US Global Research (www.usfunds.com) which produces in a tabular form - they have dressed it up to look like the periodic table of elements familiar from school chemistry lessons - a picture of the annual returns generated by a range of commodities for the years from 2005 to 2014. That’s an interesting period, because it covers the few years either side of the defining event of the financial crash of 2007/08. There are endless permutations of comparative performance that one can draw from these statistics, but first just the broad numbers. I have calculated the total return over those ten years for the major industrial metals (copper, aluminium, nickel , lead and zinc), precious metals (gold and silver), PGMs (platinum and palladium) and crude oil. The worst performing are aluminium - down give or take ten percent - and nickel and crude oil, both either side of flat. The best performers are palladium (up something over three hundred percent), gold (up about a hundred and seventy percent) and silver (up a little under a hundred and fifty percent). The rest all come in up somewhere in the area of forty to seventy percent.

Some of those changes are quite easy to understand. Palladium began the period somewhat undervalued, and its gains are mostly a direct result of industrial consumption; car manufacturers globally - for whatever reason - have rebalanced their production towards a greater use of diesel, and that has a direct effect on the balance between platinum and palladium, in favour of the latter. Gold and silver are traditional investments in turbulent times, so their gains are largely unexceptional - and don’t forget the currency element in there as well. Oil is a geo-political football as well as an essential raw material; particular circumstances have conspired to hit the price hard over the last half of 2014. The numbers don’t lie, though; oil is only marginally above its 2005 price. 

Figures and Strategies

So looking at those figures, it would suggest that simply holding an investment in metals (industrial, precious and PGMs) would have been a reasonable strategy, right? The worst elements came out not too far off flat, and the rest would have generated an attractive return. Does that mean then that the passive buy and hold, popular and recommended in recent years, is an attractive one? Were those who told us ‘metals are an asset class that should feature in a balanced investment portfolio’ actually right?

Devil in the Detail

On the surface, probably the answer would seem to be yes. However, as so often, the devil is in the detail; and the detail shows massive variability on an annual basis - and bear in mind, we’re only looking at year-on-year changes, not taking into account the inter-year volatility. The violence of the changes is such that only those with the deepest pockets could ride out the downturns, even within what is shown to be an overall upward trend. During this ten year period, there are years where the decline is greater then fifty percent; few investors are really rationally able to hold assets in the face of that kind of drop. The changes in value, and the relative variance with the inherent margin demands that creates, make such a strategy pretty much indefensible; perhaps that’s one of the reasons why industrial metal ETFs have not really prospered as their advocates might have hoped. What’s needed is a selective approach - I think my real point is that although long-term trends may be discernible, the reality is that passive investment in metals is of dubious value for most players. 

The Value of Knowledge

The good news in that, of course, is that the demand for specialist knowledge - in order to facilitate active, informed investment decisions - is likely to grow, not fall. I don’t particularly like the shift of the metal market from industrial-based hedging mechanism to ‘investment opportunities’, but at least there may be hope for those who worry for their careers as the brokerage business declines. Knowledge and understanding of the market is still going to be a commodity in demand. 

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