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Silver Mutual Funds Offer Another Option for Investors

By J.D. Seagraves
Published: August 28, 2007 in Silver Investing Articles,

There are numerous ways to invest in precious metals these days. Bullion and rare coins have always been investment options, and they’re still good ones. Gold and silver certificates and privately minted coins are some other choices. And there are also mutual funds that can offer you exposure to the precious-metals sector.

There are about thirty mutual funds which invest in both gold and silver. But as you will see, the investment styles and strategies of these funds vary greatly. Some invest primarily in mining stocks, while others hold bullion or coins. Still others offer a balanced approach. And finally, there are the exchange-traded index funds tied directly to the bullion price of gold and silver. One thing is for sure—it’s never been easier to invest in precious metals.

Two of the Best Precious-Metals Funds

Two of the best precious-metals mutual funds are Vanguard Precious Metals and Mining (ticker: VGPMX) and Permanent Portfolio (PRPFX). Both of these funds received five-star ratings from Morningstar, and yet they are quite different.

The Vanguard Fund is heavily stock-based mutual fund. As of July 31, 2007, 97% of its $4 billion in assets were invested in equities, with its largest holdings Lonmin (LMI), Impala Platinum (IMPUY), Anglo Platinum (AGPPY), and Aber Diamond Corporation (ABZ). All four of these stocks are foreign and can only be purchased by U.S. investors through ADRs—buying the fund is much easier.

As of July 31, 2007, Vanguard Precious Metals and Mining had a one-year annualized return of 22.29%. Its three-year return was even better, at 39.88%. And its five-year return was 34.01%. An investment of $10,000 five years ago would be worth $43,220 today.

Another amazing feature about the Vanguard Fund is its incredible Sharpe Ratio of 1.41 (five-year return over risk). In fact, based on the fund’s three-year, five-year, and ten-year data, Morningstar assigned it a return designation of “high,” and a risk designation of “low.”

Permanent Portfolio (PRPFX) didn’t fare quite as well. Its three-year, five-year, and ten-year returns are designated as “high,” but it’s risk is also “high” or “above average.” What’s more, its returns haven’t been as high as Vanguard’s—just 8.1%, 11.75%, and 13.06% for one, three, and five years, respectively.

But Permanent stands out when you look at its worst returns. In its history as a fund, the worst three-month period it has ever experienced is -5.58%. By comparison, Vanguard shareholders would have suffered a -29.8% three-month period if they held the fund long enough.

Remember, the Vanguard Fund is 97% stocks. Permanent Portfolio, by stark contrast, is much more well balanced. As of July 31, 2007, it was 23% in cash, 32% in stocks, 21% in bonds, and 24% in “other”—which, as you might guess, means mostly precious metals. In fact, its four largest holdings are U.S. Golden Eagles, Gold Canadian Maple Leafs, COMEX Gold, and COMEX Silver.

It’s easy enough to look at these two funds and say Vanguard is superior, but it really depends on what you want as an investor. Do you want a well-managed mining-company fund, or do you want a mutual fund that gives you real exposure to gold and silver? If the answer is the latter, than Permanent Portfolio is your best bet.

One Not-So-Good Fund

Of the thirty gold and silver funds, only two received a five-star rating. Three others received four stars, and all the rest but one were either given three stars or weren’t rated. There was just one two-star fund: RiverSource Precious Metals & Mining.

Like the Vanguard Fund, RiverSource is predominantly stock-based. As of July 31, it had 96% of its $120 million invested in equities, more than half of which were foreign securities. Unfortunately, its selections haven’t panned out as well as Vanguard’s, with only a 7.06% year-to-date return.

Another negative aspect of RiverSource is its ultra-high expense ratio of 2.15%. By comparison, Vanguard has an expense ratio of just 0.35% and Permanent Portfolio’s is just 1.11%. Both of the five-star funds are no-load, whereas RiverSource has a 1% back-end load. All of these fees and expenses can really take a bite out of your returns, especially when the fund’s performance isn’t all that hot to begin with!

Exchange-Traded Funds

Finally, there are exchange-traded funds (ETFs) that allow investors a more direct access-point to gold and silver. For gold, there is streetTRACKS Gold (ticker: GLD), and for silver, there is iShares Silver Trust (SLV). Both of these funds are tied directly to the price of their corresponding precious metal, and invest in nothing other than gold and silver, respectively.

For example, streetTRACKS Gold is priced so that one share of the fund is equal to 1/10 an ounce of gold. The iShares Silver Trust is priced so that one share equals ten ounces of silver. However, these ratios don’t always hold up—GLD recently traded for $66.57 a share while gold was $670 an ounce; and SLV traded at $127.65 while silver was priced at $12.79. Nevertheless, these ETFs do give investors an easy way to own gold or silver, at least on paper.

It’s As Easy as Point and Click

So what is the best way to invest in precious metals? It’s really up to you—your preferences and investment goals. The only thing you must be sure of is if your strategy matches your investment objectives. For example, if you want real exposure to gold and silver, it’s much better to purchase Permanent Portfolio than the Vanguard Fund—but even better yet to buy GLD and/or SLV.

But if maximum exposure isn’t your goal, the Vanguard Fund could be a great investment. The best news is there are dozens of options which simply didn’t exist ten or twenty years ago. Now, with nothing more than a few hundred dollars and Internet access, anyone can hedge with and profit from precious metals.

Popularity: 24% [?]

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Central Banks Lease Gold and Silver; Distorting Markets and Balance Sheets

By J.D. Seagraves
Published: August 25, 2007 in Silver Investing Articles,

Libertarian economist Milton Friedman once commented that the principal defect of gold and silver as monetary bases is  society spends resources extracting them out of the ground in order to store them—back in the ground—in central-bank vaults. But another libertarian-gone-mainstream, Alan Greenspan, saw another problem with precious metals—metals don’t generate interest income.

On July 24, 1998, Alan Greenspan—a former advocate of the gold dollar and opponent the Federal Reserve he now chaired—uttered one sentence that drew the ire of every goldbug on the face of the Earth: “Central banks stand ready to lease gold in increasing quantities should the price rise.” What made the goldbugs so mad? And what did Greenspan mean by “leasing” gold?

As far as Greenspan was concerned, Friedman’s issue with gold—it was expensive to mine—was somebody else’s problem. All Greenspan cared about as chairman of the Federal Reserve, was he had a lot of gold and silver in his vaults that wasn’t generating interest income. So under his watch, the Fed began increasing the amount of gold and silver leased to mining companies, as well as to other central banks and foreign governments.

Direct Leasing

The most basic form of precious-metal leasing involves central banks such as the Fed taking their gold or silver to an intermediary institution known as a “bullion bank.” Major firms such as Bank of America, Barclays, Citigroup, Goldman Sachs, JP Morgan Chase, and UBS all operate as bullion banks.

Typically, the bullion banks might pay a 1% interest rate on the gold or silver, with the promise to return it at a specified date. The bullion bank then takes the precious metal and sells it on the open market, using the proceeds to buy Treasury bonds for a 3-4% net return.

But what if the precious metal rises in price and the bullion bank has to pay more for the gold or silver it returns than it received for the gold or silver that it borrowed? To address this concern, bullion banks use the futures market to lock in a price and delivery date of the necessary gold or silver. This cuts into their profit margins but takes all of the risk out. A 1-2% net return with zero risk is a great deal for them. As for the metal lender, a 1% return is better than the 0% return gold and silver earn in underground bank vaults. It’s a win-win for the central bank and the bullion bank—but some argue individual investors lose.

Critics of metal leasing say, because gold and silver leasing artificially increases the supply of the precious metals for industrial, commercial, and investment uses, thus holding down the prices of the commodities. Central banks and the bullion banks are insensitive to the price of gold or silver—profits are locked in and guaranteed—so this distorts the real supply and demand relationship between buyers and sellers.

But could it be that holding down the price of precious metals is not just a side effect, but the intended effect of leasing? After all, just reconsider Greenspan’s words: “Central banks stand ready to lease gold in increasing quantities should the price rise.” It’s quite possible that, in the absence of gold leasing, government fiat currencies would appear virtually worthless as they rapidly depreciate against gold.

Gold and Silver Swaps

Even more insidious is the action of “swapping,” which is most commonly performed with gold. Essentially, two central banks literally swap hordes of gold—with the objective of doing nothing more than muddying the accounting waters.

A second type of gold swap involves only one central bank’s gold reserves, which are lent for currency to another central bank. The real problem with this tactic is the banks consider these swaps to be “collateralized loans,” and thus they don’t appear on their balance sheets. No one knows for sure just how much gold and silver the Fed and other central banks have lent to each other this way.

In fact, the situation is getting so bad that the International Monetary Fund (IMF) is actually beginning to take gold swapping seriously. The IMF has recommended that these types of swaps be recorded on the balance sheets of central banks, and the rule could become mandatory by 2009.

Mining Companies

But central banks and the bullion banks aren’t the only bad guys in the precious-metal leasing story: Mining companies deserve a share of the blame, as well. Despite the near-sightedness of it, many of these companies participate in the leasing themselves by borrowing gold from the Fed or other central banks, selling it, and then later replacing it with new gold fresh from the mine.

Of course, considering gold leasing suppresses the price of gold, and generally, gold-mining companies benefit from higher gold prices, borrowing gold isn’t really in a mining company’s long-term interest—but since when has that stopped someone from making a short-term buck?

Is the End in Sight?

For all intents and purposes, silver leasing has come to an end. This happened because, finally, central banks were essentially out of silver. Most silver analysts expected this would result in a major bull market in silver, and while it did impact the market in a positive fashion, the price of silver has still been suppressed by a concentrated short position held four traders whom many analysts consider to be market manipulators.

Gold leasing, on the other hand, is still alive and well. But like silver leasing, it too must come to an end. The difference is when gold leasing is unwound, there won’t be a concentrated short position holding gold back. Many goldbug analysts predict gold could see $2,000 an ounce when central banks stop leasing gold.

The question is not if central banks will stop leasing gold—the question is merely when. But the real question is: Will you profit from it?

Popularity: 12% [?]

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