The Benefits of a Diversified Precious-Metals Exposure

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1 The Benefits of a Diversified Precious-Metals Exposure July 26, 2016 by Robert Huebscher ETF Securities provides accessible investment solutions, enabling investors to intelligently diversify their portfolios beyond traditional asset classes and strategies. They are pioneers in specialist investments, having developed the world s first gold exchange-traded commodity. It offers one of the most comprehensive ranges of specialist exchange-traded products (ETPs) covering commodities, foreign exchange and thematic equities traded on major exchanges across the world. I spoke with Maxwell Gold, director of investment strategy at ETF Securities, on July 15. Your firm is best known for its gold-based ETF (SGOL) and its precious metals-based ETF (GLTR), but those are only two of nine ETFs you offer for U.S. investors, which are part of a larger lineup of exchange-traded products. Can you please provide some background on the history of your firm and the strategy behind the product line you have developed? Our firm was founded on the principle of being an innovator within the commodities space. We ve recently branched out into broader alternative investment solutions, and that s where we see ourselves having an opportunity to continue to add value for clients and investors through product innovation. We launched the world s first physically backed gold ETF in 2003 overseas and expanded our footprint in commodities across Europe and the U.K. In the U.S., we ve continued this heritage through our core product suite within the precious metal complex including a broad-based precious metals physical basket (GLTR) and individual physically backed gold, silver, platinum and palladium ETFs. But beyond that, we have looked to branch out into other strategies that are focused on providing access to unique or alternative exposures that advisors and investors can utilize within asset allocations. We have four equity funds, including two smart beta products and two Zacks earning factor products where we offer investors access to unique thought leadership in an ETF wrapper. Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.

2 We continue to look for key themes and factors that are driving alternative exposures for advisors and investors to utilize within the broader context of their portfolios. What trends are you seeing now in your precious metals funds, particularly with respect to flows and performance? We are seeing strong interest so far this year. It s been a great story for precious metals and, to a larger extent, the commodity complex so far in Rewinding to the end of 2015, the Fed had just started its rate-hiking cycle by raising rates 25 basis points in December, and sentiment for precious metals and commodities in general was very negative. That has since seen a complete reversal. Investor sentiment has come online and reversed from what had been net bearish to net bullish as well as extending their long positioning to record highs in gold and other precious metals. This change has been on the back of a lot of uncertainty in the global macroeconomic environment and expectations of a slower path of the Fed s hiking cycle, as well as diverging monetary policies between the U.S., Europe, Japan and other emerging markets central banks. There remains a lot of uncertainty and a lot of macro headwinds as the global economy looks to sluggishly extend its growth following a weak recovery from the financial crisis of Beyond that, the precious metals space has been the top performing asset class so far this year, outperforming equities, fixed income and other alternatives, across the board. We are seeing the return of investors and their interest in precious metals, gold in particular. Globally across our physically backed precious metals ETFs, we ve seen record volumes year-to-date as well as strong continued inflows, and within the U.S., our precious metals ETFs have had record inflows so far in the first half of this year. What was the impact of the Brexit vote on your funds? On the back of the most recent concerns around Brexit, we ve seen precious metals react as the traditional safe haven hedge against event risk. Since the vote came as a surprise to many, we saw very strong performance when Britain decided to leave the E.U., which has been an additional tailwind for precious metals this year. We are seeing strong performance year-to-date within the other metals as well. Silver is the top performer so far, followed by gold, and overall the precious-metals complex is up about 30% so far this year through July. One of the issues you discuss on your website is the importance of holding precious metals in different vault locations, compared to traditional commodities. Can you elaborate on this issue? What s unique about our gold product, SGOL, is that it vaults the physical bars within the trust in Zürich, Switzerland, as compared to a lot of our competitors that choose to vault in London for their gold ETF products. SGOL was launched to acknowledge that the vaulting location of the physical gold Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.

3 within an ETF is a critical decision for investors, and reflected the demand from investors to diversify any potential counterparty risk stemming from the geographic vault location. Switzerland presents a unique option for vaulting given its critical role within the global gold market. It is central for global gold refining, trade flows between London and other hubs, and geographically acts as weigh station for gold to reach consumers throughout the globe. Homing in on Switzerland s historic track record of geopolitical and monetary stability makes it a unique option for investors to further diversify their gold holdings and not be concentrated to any one single physical location. How are advisors using precious metals in client portfolios? Precious metals are first and foremost a critical risk management tool for investors. Primarily, advisors are looking to precious metals as a source of diversification against equity and other risk assets in their portfolios. Since the financial crisis of 2008, diversification has become more complicated and more difficult to achieve. Equities, fixed income and alternative assets globally are much more highly correlated and have begun to move more tightly together. The one exception is precious metals. They have not only generated a low correlation to equities before the financial crisis, but during it and after it too. Their equity correlations have actually come down since before the financial crisis. That has not been the case for other traditional alternative assets, such as real estate, REITs, hedge funds, private equity and a broad commodity basket. This has been a key driver by advisors to incorporate precious metals to help manage the overall risk in client portfolios. An advisor who invests passively and holds, for example, a market-capitalization weighted fund of global equities will have some exposure to precious metals. Why is that exposure insufficient? Taking a quick look at the S&P 500 on a market-cap basis, the metals and mining sub-industry accounts for about 40 basis points or 0.4% of the total index. The only gold miner within the S&P is Newmont Gold. When you expand that to the broader all-country world Index, the MSCI ACWI, which accounts for both developed and emerging markets, metals and mining is about 1.6% of total marketcap of which gold and precious-metals mining is only about 0.5%. In terms of broad metals and mining, the market-cap-weighted equity indices don t have really any tangible exposure. From a precious-metals mining perspective they have a very, very small and immaterial exposure. That s why it s critical to look for direct pure-play investments into this space to capture their unique diversification and risk-management properties within a broader stock-bond portfolio. For advisors, precious-metals investing particularly in gold has been a contentious topic. Most of the concerns I ve heard fall into three basic categories. I d like to ask you about each of those. First, there is academic research that shows that gold, over the long term, has not been an effective inflation hedge. How do you respond? Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.

4 That it is accurate. In fact, when comparing gold to U.S. inflation, it s historically been a terrible hedge. There are other investments to hedge against U.S. inflation that were explicitly created to do so. One example would be TIPS, or Treasury inflation-protected securities. Gold is really great at acting as a store of value and preserving purchasing power over the long term. When you take into account increasing prices in conjunction with currency fluctuations appreciation or depreciation in currencies that is really where the power and the store-of-value ability of gold comes into play by maintaining spending power over time. It is much more accurate to say gold acts as a global inflation hedge, given its sources of supply and demand come primarily from emerging markets, particularly India and China. This has shifted over the past 30 years when gold fundamentals were concentrated amongst developed markets, such as the U.S. and Europe. Gold also has the ability to act as a hedge against extreme hyperinflation, or extreme hyper-deflation, as we saw historically in 1933 in Germany, in the Weimar Republic, and in 2008 in Zimbabwe where they suffered hyperinflation. That plays much more so into gold s purchasing-power preservation over time, in conjunction with diversification against currency depreciation. Second, I ve heard advisors argue that commodities in general, and precious metals in particular, should not be considered an asset class like stocks or bonds because they do not represent a fractional interest in an entity that generates cash flow. What is your response to that concern? Essentially when one makes the argument that, Oh, it has no cash flow and therefore it doesn t have any intrinsic value, this is a bit dismissive about what is unique to precious metals. There are lots of investments that don t have cash flows for which it would be hard to argue that they don t have value. For example, a lot of growth stocks or tech stocks don t have any dividends, earnings or revenue growth, but one would be hard pressed to say these do not have any value just because they lack cash flow. For assets like precious metals, you re applying an equity-focused framework and it s almost like putting a square peg through a round hole. You need to apply a different evaluation model that is beyond looking at a discounted cash flow model or valuing it with a present value of its expected future cash flows. This is partly why we view that gold and precious metals should be separated as an asset class of their own. There are unique investment exposures and qualities to warrant this, not just compared to stocks or bonds, but also within the alternative assets space and even among commodities. Whereas commodities have very high exposure to equity factors and are much more cyclically related, a basket of precious metals has a much lower correlation to not just U.S. but global equities, which over time has been sustained. This is why precious metals are a true diversifier and should be viewed as a true alternative asset. Third, I ve heard the concern from advisors that the vast majority of their clients can t afford Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.

5 to add an additional allocation to gold or metals to protect against a global calamity, and that it only makes sense for very wealthy investors to make those investments. How would you respond to this concern? All asset allocations among stocks and bonds can benefit from increased portfolio efficiency by adding an allocation to precious metals. The optimal allocation to precious metals may vary depending on one s risk profile, but it is never 0%. By adding an allocation to precious metals, we see portfolio efficiency increase, whereby returns have increased and volatility has decreased historically compared to a stock/bond portfolio with no allocation to precious metals. What has been great about the evolution of the physically backed precious-metals ETFs is that it s democratized investing in precious-metal by allowing low-cost, efficient, transparent and liquid vehicles that are pure plays in these metals and accessible to investors of all sizes. Turning back to the benefits of precious metals, what are the advantages to holding a basket versus individual commodities? A great reason to hold a basket of precious metals compared to broad commodities is that they act as a great portfolio risk management tool. If you look at broad-commodity indices, they are typically overweight cyclically sensitive sectors, particularly energy and agriculture, whereas their lowest allocation is to precious metals. A lot of people invest in broad-based commodity Index funds not realizing their exposure to precious metals might be insufficient or lower than they expected. Direct exposure or investment to precious metals is warranted in addition to a broad commodity investment to help gain the diversification and risk management benefits that precious metals offer for investors. Where are precious metals headed from here? We're getting a lot more interest from investors this year on the back of the very strong performance that we've seen in the precious metals space. Precious metals and broader commodities seem to have hit a bottom and turned the corner. A lot of the downside concerns on the price risk have been removed from the table, and a higher floor can be expected for precious metals. We see continued upside benefits from precious metals going forward, particularly in an environment of continued episodic volatility and global uncertainty. We ve seen a lot of question marks raised so far this year, the least of which has come from the Fed and from the recent Brexit decision. Going into the fall, we can expect more questions about the direction of the economy, potential changes in monetary policy and the U.S. presidential election to continue to weigh on markets. We see the benefit of holding precious metals in a diversified portfolio to hedge and dampen any upcoming volatility as the global focus shifts from one macro event to another. Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.