Seeking a safe haven

Concerns surrounding rising government deficits and the outlook for the US dollar are sparking interest in gold ETPs while the growing auto-catalyst industry is boosting precious metals. Emma Dunkley reports

The Greek sovereign debt crisis has neatly illustrated escalating government deficits across Europe, fuelling a rush to gold as a safe haven asset. This move has bolstered inflows into exchange-traded products (ETPs) tracking the commodity over the last few weeks in particular. The year has certainly seen a strong start for ETPs based on the precious metals group, which have gained around $400m of global ETC inflows according to ETF Securities (ETFS). The firm says continuing weakness of the euro has also pushed gold spot prices to a record high, surpassing $830/oz around mid-February. 

Over the longer term, gold has delivered over 160% in US dollars, euros, GB sterling, Australian dollars and Japanese yen, in the 10 years ending 31 December 2009. ETFS senior analyst Daniel Wills says renewed concerns surrounding sovereign credit risk at the start of the year have helped foster demand for gold as a hedge against currency debasement and financial market dislocation. 

Precious metals

Along with gold, the precious metals group comprising silver, platinum and palladium has experienced the strongest inflows year to date, exceeding peaks set by the group in late 2009. Wills says the close links between precious metals and emerging market growth, through their use in auto-catalyst technology, has pushed these metals into further prominence with the recent emergence of China as the world’s largest car market. 

Palladium has been the best performing of the precious metals over the last three months, in terms of total returns in sterling. The ZKB Palladium ETF tracking the palladium spot price, with Swiss francs as the base currency, delivered the best return in this time frame at 31.08%. This was followed by ETFS Physical Palladium, also tracking the spot price but denominated in euros, returning 23.97% in the same time period. 

Nicholas Brooks, head of research and investment strategy at ETFS says: “Other precious metals did far better than gold last year although they got less attention. Platinum was up 63% last year, offering a stellar return, although top of the range was palladium, up 114%.” Nonetheless, Brooks adds there has been extremely strong interest in gold amid concerns about solvency risk and the outlook for the US dollar. 

The ETFS Physical Palladium is 100% backed by physical metal stored in vaults. Brooks says the physical-backing has been one of the great appeals through the financial crisis and one of the reasons why the firm has seen large inflows. He adds: “With concerns about counterparty risk on the rise, investors like the idea of investing in something tangible.” 

Brooks explains platinum and palladium are likely to see strong demand over the medium to long-term, as the metals are crucial to auto-catalysts used for emission control on autos. They therefore present a direct play on rapid auto demand growth in China and India among other emerging markets and also on tightening emission standards globally.

He adds: “Consumption of automobiles in China and India is extremely low on a per capita basis, but analysts believe this will increase at a rapid rate in the coming years. Rising per capita consumption when combined with the size and growth of the middle classes in these countries should continue to drive strong demand for platinum and palladium.” 

As the price of platinum and palladium is strongly geared to the industrial cycle, Julius Baer executive director Stephan Mueller says these metals are driven by small signals detecting economic rises or falls. He adds: “We have seen the drop, through the financial crisis. Now we can profit from the economic recovery because of a greater volume of car production on one side, and the need for reduced emissions through auto-catalysts on the other.”

Ahead of the pack

Despite the strong, rising performance exhibited by platinum and palladium at present, World Gold Council (WGC) head of investment Jason Toussaint says gold is a truly global asset providing diversification, whereas platinum and palladium are largely used for the industrial sector. He says: “When you have market events like 2008 where there’s a huge global downturn, generally the industrial metals are affected at the same time, because the business cycles are depressed. Gold stands out, uncorrelated.”

However, Toussaint explains the importance of understanding the structure of ETPs based on gold, as products backed by derivatives such as futures, options and swaps can deliver returns which largely differ to the spot price of the commodity. He says: “By investing in futures, for example, you hardly ever get the return of the underlying metal’s spot price, due to backwardation and contango in commodity markets.” He says creating ETFs that are physically-backed resolves this issue, and adds ETFs tracking metals are currently the only commodity funds that are 100% backed by the underlying stock product.  

Indeed commodity prices based on derivatives are subject to changing sentiments and expectations, which can shift prices up and then subsequently allow them to fall sharply, says Mueller. He adds: “On one side we’ve seen fantastic price development in gold, but on the other side, we’ve had concerns because the price was driven more by expectations than fundamental flows.” He says whenever Julius Baer sees real flows and subscriptions for its funds, the firm has to buy new gold, which marks a real price development. 

The JB Physical Gold fund is a regulated structure according to Swiss law and is not a debt security. Mueller says: “It’s nonsense to combine gold, which is supposed to be a safe-haven asset with a debt security, because you are then exposed to counterparty risk. With our fund set-up, investors are completely delinked to the prosperity of Julius Baer.” Mueller notes it is important for investors to understand they have physical ownership of the metal via the JB fund and do not have to claim the delivery of the metal.

In order to further mitigate counterparty risk, Mueller says Julius Baer does not permit lending or borrowing of the underlying gold. He explains as soon as the underlying is lent or borrowed, the investor is no longer the proprietor of the commodity. He adds: “A lot of product issuers try to get additional income this way, but we do not do this because our fund is supposed to be the safest kind of product.”

Click here for a table of Precious metals ETFs