Kevin Feldman's  Instablog

With many financial innovations, institutional investors are often the first in; they hear about the innovations early, or they quickly figure out ways to use them. Later the retail investors follow.

ETFs, however, have shown a slightly different pattern. After 1993, when the first ETF was introduced in this country, ETFs were primarily of interest to institutional investors. At first, their main use was as a place to hold cash before investing in a new asset class, but institutions soon began using them for other purposes, such as tactical allocations and hedges.

In the past decade or so, retail investors overwhelmingly became the most frequent ETF purchasers. Many retail investors bought ETFs after feeling burned by the bursting technology bubble of a decade ago, likely because they learned that diversification in a portfolio can be beneficial.  But now we’re seeing the trend come full circle: According to a just-released report by financial research firm Greenwich Associates, “institutional investors are increasingly bullish” on using ETFs in their portfolios.  Greenwich interviewed 45 institutional funds, including corporate pensions, public pensions, endowments and foundations, about their interest in ETFs; they also interviewed 25 large asset management firms in the U.S.

The results? Forty-eight percent of asset management firms interviewed planned to increase their portfolio exposure between now and 2013, and none planned to decrease it. And though current ETF holdings are small relative to the total of funds these firms have under management, they constitute about half of ETF assets invested nationwide.

What’s causing the growth of institutional investment in ETFs?   A primary reason is that institutional investors have developed or simply come to appreciate additional ways in which ETFs can support and strengthen their overall portfolio strategy. The firms are still using ETFs for cash equitization (a place to put cash that’s in transition rather than keeping large amounts out of the market); and they’re also still using ETFs as an interim strategy during a shift from one fund manager to another.

But, the Greenwich report says, institutional investors are doing much more with ETFs, including using them for hedges or to acquire exposure to asset classes that aren’t always easy to access, and for the sake of liquidity.

Why is this good for retail investors?  Because many large pension funds are managing money on behalf of millions of individual investors, who are in turn exposed to the benefits that ETFs provide, including relatively low cost, tax efficiency, and transparency. 

Diversification may not protect against market risk.

There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.

Transactions in shares of ETFs  will result in brokerage commissions and will generate tax consequences. ETFs are obliged to distribute portfolio gains to shareholders. 

Neither SEI, and its affiliates, nor BlackRock Institutional Trust Company, N.A., and its affiliates, are affiliated with Greenwich Associates.

In 2010, for the first time in 20 years, the world’s central banks bought more gold than they sold, perhaps a reflection of anxieties following the global economic crisis and a sense of gold’s historical reputation as a repository of value. Over the past three years, Europe’s central banks really haven’t sold any gold at all; between December 2010 and February 2011, they collectively sold a whopping .2 tons of their gold, according to a recent report.

But they are buying gold. Russia has been purchasing gold every month this year, adding 18.8 tons since January. Bolivia has increased its reserves by over a third, from 28 tons to 37 tons. Also since January, according to Bloomberg, Mexico bought 93.3 tons of gold (formerly it held just 6.9 tons); in the same period, Thailand bought 9.3 tons.  

Why is this important? Because these purchases by the world’s central banks aren’t likely to turn into sales anytime soon.  With Western central banks still stabilizing the global economy with exceptionally low interest rates and emerging market countries keen to diversify their dollar reserves, there’s still plenty of room for continued buying.

That’s no guarantee that the price of gold will continue to rise, of course, or that it won’t even drop. There are other players, like hedge fund investors, in the picture.

But it is one reason not to draw conclusions about the direction of the price of gold by looking at the price of silver.

Source: World Gold Council

iShares Gold Trust (“Trust”) has filed a registration statement (including a prospectus) with the SEC for the offering to which this communication relates. Before you invest, you should read the prospectus and other documents the Trust has filed with the SEC for more complete information about the issuer and this offering. You may get these documents for free by visiting www.iShares.com or EDGAR on the SEC website at www.sec.gov. Alternatively, the Trust will arrange to send you the prospectus if you request it by calling toll-free 1-800-474-2737.

Investing involves risk, including possible loss of principal. Because shares of the Trust are created to reflect the price of the gold held by the Trust, less the Trust’s expenses and liabilities, the market price of the shares will be as unpredictable as the price of gold has historically been. The Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Trust are not subject to the same regulatory requirements as mutual funds. For a more complete discussion of the risk factors relative to the Trust, carefully read the prospectus.

Much of the world’s known supply of gold is already above ground. It is practically indestructible and has limited commercial use—most of the world’s gold is either in storage or in jewelry—so it’s constantly being recycled. There is, on the other hand, a large supply of silver; it’s obtainable both directly through silver mines and indirectly as a byproduct from other commodities being mined. Silver mining is responsive to demand, and as the price of silver has risen, new mines have opened in places as different as Brazil, Africa and even Texas, where a mine reopened after being closed for over 60 years! As you can see in the chart below, silver mine production was already rising (up 2.5% last year). The output of new mines will enlarge the silver supply even further and could reduce future prices.

While many private investors may think of silver as a hedge against inflation and a form of money, the world’s central banks do not.

The world’s central banks store gold as a foundation for their national currencies and have recently been net buyers, increasing their gold reserves. That’s not only an enormous source of demand for gold, but at the same time a reason why much of the world’s gold supply doesn’t circulate on open marketplaces. I haven’t been able to find any consolidated published central bank holdings of silver as a reserve. I had to go back to this 1923 report helpfully furnished by the St Louis Fed to find a time period when central banks viewed silver on par with gold as a reserve.

Historical patterns demonstrate that the prices of silver and gold don’t always rise and fall together. 

Gold has had price volatility that is more than bonds, but slightly less than equities. But the price of silver has been much more volatile (as shown in the chart below) and sometimes in a completely different direction than gold. Take 2008 for example, when the price of silver declined 27% and the price of gold rose 6%. This is the reason many advisors allocate a small portion of an investor’s portfolio to gold--because of its historical diversification benefits, especially during turbulent market cycles.

 
And remember that silver is likely not a good longer-term substitute for gold based on fundamental and historical evidence. Investors who see both gold and silver as a precious metal safe haven should remember their key differences.

Sources: Morningstar Direct, Bloomberg

iShares Silver Trust (the “Silver Trust”) has filed a registration statement (including a prospectus) with the SEC for the offering to which this communication relates. Before you invest, you should read the prospectus and other documents the Silver Trust has filed with the SEC for more complete information about the issuer and this offering. You may get these documents for free by visiting www.iShares.com or EDGAR on the SEC website at sec.gov. Alternatively, the Silver Trust will arrange to send you the prospectus if you request it by calling toll-free 1-800-474-2737.iShares Gold Trust (“Gold Trust”) has filed a registration statement (including a prospectus) with the SEC for the offering to which this communication relates. Before you invest, you should read the prospectus and other documents the Gold Trust has filed with the SEC for more complete information about the issuer and this offering. You may get these documents for free by visiting www.iShares.com or EDGAR on the SEC website at sec.gov. Alternatively, the Gold Trust will arrange to send you the prospectus if you request it by calling toll-free 1-800-474-2737.