By Hannah Tool
Mike McGlone, director of research for ETF Securities, talks up a bullish outlook on precious metals and the importance of incorporating the ‘big four’ into a basket.
With three-quarters of 2013 behind us, looking back at the year brings one question to the forefront for the fourth quarter: What’s in store for precious metals? The big four—gold, silver, platinum and palladium—can be fan favorite or portfolio nightmare. Mike McGlone, U.S. director of research for ETF Securities, shared his outlook for the last quarter of the year with contributing writer Hannah Tool, dipping into how the international landscape will play into the metals movement, and why auto sales are so important to industrial precious metals.
HardAssetsInvestor: Looking at the four big precious metals—gold, silver, platinum and palladium—what is your outlook heading into the fourth quarter of 2013?
Mike McGlone: We have been bullish and remain bullish. I think it’s this question of which ones we’re more bullish on, and for which reasons.
You can separate out gold and silver as the investment-oriented and sometimes store-value types. Platinum and palladium are a little more of the industrial-sensitive precious metals. But we remain bullish on all four. We don’t really put targets on things, but we still think they offer pretty attractive value.
HAI: What percentage do you advise in terms of precious metals allocation to a portfolio?
McGlone: Historically, we look at between 5 to 10 percent allocations for the precious metals and for diversification of portfolios, but that’s obviously dependent on the individual preferences.
HAI: All of your U.S.-listed ETFs are physically backed, right?
HAI: When it comes to precious metals, does a physically backed portfolio perform better than a futures-based portfolio?
McGlone: You cannot get more transparent access to platinum, palladium, silver or gold than in a physically backed ETF.
When you have a futures-based portfolio, you have many layers of exposure before you're getting to the actual metal or the actual commodity. It’s a derivative. So you're not getting direct exposure to that actual commodity entity. Because of that, you're going to have a lot of nuances.
With any physically backed product, the only difference between performance of that product and the metal is the expense ratio. You don’t have to deal with issues of backwardation, contango and the roll return, which, in futures, not only is there a roll return, there’s an expense to that roll return. You just don’t have to deal with all the issues of ownership.
HAI: Are the ETF Securities physically backed ETFs redeemable for physical bullion?
McGlone: Yes. Our gold ETF, SGOL, is redeemable at 50,000 shares and for silver fund, it’s 100,000 shares.
HAI: Looking forward one, three or even five years, what do you think will be some key factors that will roll into the upward or downward fluctuations in gold pricing?
McGlone: There’s one key factor that I don’t think a lot of people are really speaking about yet: The light at the end of the tunnel is tightening at the Fed.
Something that people have to think about and look at is that, generally, the concept of Fed restraint and tightening is considered bad for gold. We thought so, too, until we went and checked the history. Historically, the price of gold has actually performed quite well during Fed tightening cycles.
The last time the Fed started a tightening cycle was June 30, 2004, when the Fed funds were about 1 percent. At that time, the consumer price index (CPI) was 3.3 percent. Currently, CPI is below 2 percent.
What investors need to be concerned about when investing in precious metals is the potential Fed tightening in the near future. Just ask yourself the question, If and when the Fed is going to tighten, what is the landscape going to look like?
HAI: In 2004, when that last “tightening” occurred, unemployment was at 5.6 percent. How far off that mark are we?
McGlone: At the current pace of the drop in unemployment, it might not happen until 2016, depending on what measure you use. However, we did a little research, and if we stay at the current pace of the drop in unemployment, that’s something to look forward to.
As far as looking way out on the curve, it might be a long time before we see any type of real constraint from our Federal Reserve. But during that period, what are we supposed to do? What should we expect? We should get a decent pickup in CPI.
HAI: What does it mean for investors if the CPI doesn’t increase?
McGlone: Overall, it can build quite a few more bullish scenarios for the precious metals, certainly gold and silver, for a stored value in an environment in which we’ve recently had a pretty substantial correction. Our advice is that correction was within the bullish trend, which is really being supported by the same things that supported it earlier.
HAI: What brought the gold market to the unprecedented highs of two years ago?
McGlone: Sovereign debt issues got the market to those highs. The Fed and the S&P downgraded U.S. debt just four days after Congress signed the Budget Control Act in August 2011.
Then, a month later, gold prices reached a new high. During that whole period, we had major sovereign debt issues in Europe; Greece and Ireland, but also Spain and Italy, were on the issue of potentially being too big to bail out.
That’s another key thing people have to keep in mind: What is this trend in global sovereign debt? We all know what's coming up at the end of October, according to the Treasury Secretary. The U.S. government is going to meet its budget ceiling.
HAI: Do you think ETPs help to drive precious metal prices at all?
McGlone: The total holdings of ETPs in gold and silver account for about three-quarters of annual supply. For instance, in silver, the total holdings are 645 million ounces, and total annual supply in silver is around 800 million ounces. Gold ETF holdings are around 62 million ounces, and total annual supply of gold for miners is about 90 million ounces.
When you take a physical commodity off the market initially and put it away in an ETF, it will reduce supply and have a certain bullish impact on price. A key thing to point out is that’s also going to have a bearish impact later, which is what happened this year in gold.
Platinum and palladium, on the other hand, are really new to the market. Platinum and palladium ETFs total holdings are about 2 million ounces each, and annual mining supply is about 6 million ounces each, which makes the total ETF holdings of platinum and palladium about one-third of the annual mining supply, although that percentage held in ETPs is growing for platinum and palladium.
Long answer to your short question answer is, “Yes, there's a certain bullish impact initially.” But you have to remember that these are just more efficient, easier ways to hold these metals. They can be just as bearish as they are bullish, depending on which way they're flowing.
HAI: With less percentage held in platinum and palladium than in silver and gold, do you see funds with exposure to all four metals gaining more traction, or do you think that’s a short-term trend?
McGlone: I see it as a long-term trend. Let me give you an anecdotal example.
I was meeting a wealth manager on the West Coast a few months ago and he said he was very happy to be lightening up on some of his pure gold ETFs and buying some of the more basket-oriented ETFs.
He said that gold really has its place, and certainly has a stored value in something, especially in certain times of crisis when financial assets have issues. But lately, as the global financial crisis has been alleviated, he’s been very happy to roll some of his clients’ money out into exposure to more industrial-sensitive metals.
HAI: What real benefit do these multiple-metal baskets have over single-metal holdings?
McGlone: The key benefit is that these baskets generally have very low correlations to most other asset classes, including equities. As investors can sense more financial crisis issues coming up, like the current situation in Syria, then maybe a migration back towards more gold and silver is more appropriate. But right now, things are pointing towards lack of financial crisis.
HAI: Speaking of equities, auto sales in the U.S. and China have been pretty strong recently. Have you seen that affect platinum and palladium directly?
McGlone: Certainly. I like to look at cumulative totals for global passenger car and truck sales. That level is close to 80 million units, and it’s increasingly printing new highs.
Platinum and palladium have been stagnant the last few years, yet total passenger car and trucks have moved on. I think there is an argument that tends to say that they are becoming much more attractive, and there's certainly a correlation.
The key thing about the demand for auto catalysts is that platinum and palladium are the few commodities for which deficit demands exceed supply, and it’s expected to remain that way this year and next year.
There's also the key factor of increased emission controls. When you see images of people in Beijing wearing masks to protect themselves from smog, it’s clear that there has to be something done about emissions. These controls are not just for automobiles, but for commercial vehicles, and that’s actually helping to create additional demand for platinum and palladium.
HAI: There’s been a rising demand for gold in emerging markets. How can you correlate that demand with the recent decline in prices?
McGlone: Part of the record amount of demand that we saw this year in gold and silver has been elastic response to the correction in price. There’s been a decent amount of ETP selling of gold, and physical, more strategic buying of gold in India and China. We predict that this year China will become the largest demand factor for gold in the world, taking up to almost 30 to 40 percent of annual supply.
The key thing is, when China imports gold, it’s basically almost removed from the market. It’s not like being put into an ETP. There are restrictions to selling gold or to exporting gold out of China. So this buying in China is much more strategic than speculative.
We should expect prices to be more elastic, meaning as the price of precious metals increases, that physical demand will probably be less evident. But it should be a good example of how much demand was below the market. It’s unlikely that demand is going to do anything but continue to increase.
HAI: How does the situation with South African mining strikes affect industrial precious metals?
McGlone: When we think of South Africa, we think of platinum. The labor issues—who knows when they're going to be smoothed out—are certainly not helping add to the supply/demand efforts. We expect it to continue for a while. But it certainly keeps active in this deficit situation of platinum and palladium in helping build the market.
When might it change? Hard to predict. Even if they are able to improve the labor situation, it would take a long time to get production back online. However, what we see is that demand is still outpacing supply. It helps build a bullish case, most notably for platinum and palladium.