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Gold and Silver as an Asset Class

Paul Justice, CFA

Paul Justice: Hi, I'm Paul Justice, director of North American ETF research at Morningstar. We're here today to talk about some precious metals, potential hedges for inflation or currency devaluations, and I'm joined by Tony Rochte, the head of the intermediary distribution business over at State Street, and Abraham Bailin, our commodities ETF Analyst.

Gentlemen, thank you for joining me.

Anthony Rochte: Thank you.

Abraham Bailin: Sure. Thanks for having us.

Justice: Tony, you run the second largest ETF on the market today, and the first largest, but the second largest is by far the largest precious metals fund on the planet, the SPDR Gold Fund--GLD is the ticker.

Could you talk about some of the benefits for owning GLD in a portfolio as a potential hedge against inflation, currency devaluation, or just the general attributes of having that in your portfolio?

Rochte: We launched GLD, the SPDR Gold Trust, in late 2004. We knew it would be a successful product. We certainly had no idea it would grow to $53 billion over the course of the past six years, but what's interesting about GLD, it really provides unique exposure for all different types of environments, whether it's an inflationary environment, what I call the fear trade in obviously 2008 into 2009, and what we've seen a lot more of is gold as an asset class.

So when we talk to institutional investors, when we talk to foundations and endowments, they really think differently about gold today than they did 10 or 15 years ago. 10 or 15 years ago, gold might have been a trade. Today, they really view it as a portion or a sleeve in any well-diversified asset class.

Now, the portion depends on the risk profile. It's not uncommon to see a weighting of anywhere between 3% to 5% in a well diversified portfolio. But again, what GLD did for the industry, it helped create a rethink on gold as an asset class, and that's why regardless of the environment, whether it's a bullish environment, whether it's a bear market, we continue to see demand for this asset class.

Justice: Now, I've always loved the simplicity of the fund, just holding the bullion directly and giving people that choice if they want to access gold. And by no means is gold the right investment for everyone. There is a use in asset allocation; I think it's extremely difficult to speculate on prices. You could use GLD for that function, and I think we've actually seen some people doing that in other precious metals funds, and namely, we've seen it in a silver product.

Abe, if you could, talk about some of the asset flows we've seen actually into silver, which is a good competing asset for gold, but not a direct substitute.

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Bailin: Sure. Well, while gold has actually seen outflows month-over-month for the last several months now, really the silver play has begun to gain some traction, and silver has picked up a fair amount of assets month-over-month, and it's really important that you note that silver has a few differences from its shiny yellow counterpart in that it's primarily an industrial metal, not a like a monetary mental like gold.

Justice: Sure. Gold's a historic relic of currency and generally when it's pulled out of the ground, we refine it, put in a bar, and we put it in the ground somewhere else, but actually most of the silver that's produced is going to get used in some industrial fashion.

Bailin: Sure.

Justice: Could you talk about that breakdown a little bit?

Bailin: Yeah. So, anything from batteries to bearings to water purification or even solar power…

Justice: Let's not forget some people actually use film still?

Bailin: Right. And photography applications. Industrial applications where you actually need to use physical silver to some end use have accounted for roughly 40% of demand over the last 10 years. Now, that's dropped a little bit as these physically-backed silver funds have become proliferated a bit.

Justice: So, we're looking at $14 billion in assets, so roughly we are looking at a new source of storage or a new source of demand for silver that really didn't exist five years ago. Could you give us an idea of how much silver was actually stored five years ago versus where it is today?

Bailin: Well, it really depends on what context you are looking at--certainly there were a host of jewelry applications and silverware applications, but as far as vaulting went, really there wasn't too much to speak of it at all, and there has been a bit of a paradigm shift in that respect now with the proliferation of funds like SLV that actually do vault silver in order to back their shares. Reason for that is that they are actually drawing down supplies that would have gone to physical uses beforehand.

Justice: So, you've got industrial consumers who are competing against these people who want to hoard the metal and put it in the vault. They can't really shut off production of their end used goods very quickly, so that marginal cost can really shoot up on that.

Bailin: Sure. You get a bit of feedback, right? Because not only is there the entrance of a new demand with investment demand driven by these exchange-traded funds and the close-ended funds, but at the same time you are drawing down those supplies.

Justice: And to Tony's point, I totally agree with the asset allocation plan on precious metals; you want to have it in there as that hedge and a smaller portion of the portfolio, and be sure to rebalance that take. It's still only going to work if you're getting an effective price for the metal to put in there. I can't argue that gold is over or undervalued, I think that's left to whatever people are willing to pay, but if I look at these two relative to each other, silver at 63 times back in November looked like a pretty good buy, if you want it, you can buy that.

Bailin: Sure. The reason for that is that the precious metals group overall--so platinum, palladium, silver and gold--really feel some of the same tailwinds, when people are looking for safe-haven assets these metals are associated with their precious metals group, and namely gold. At that time the gold to silver ratio in a historical context was relative high. Since then, over the last 15 months, the case is quite contrary, and we're sitting at about 40 now.

Justice: Which we've only seen two times in the last 30 years--so we have to go back to '70s and think of things like Bretton Woods. Fascinating stuff.

Tony, if people are still worried about inflation hedges, disaster hedges besides The SPDR gold product, what other things can they really look at within the SPDR suite of products?

Rochte: Well, look, obviously GLD is the ultimate hedge, if you look for centuries gold has served that unique purpose. I think the other trend is, obviously, domestic TIPS--inflation protection through U.S. TIPS, but also international TIPS. I know I spoke to Scott Burns recently, WIP which is a SPDR Deutsche Bank International TIPS portfolio, actually provides developed market and emerging market exposure to inflation protected bonds.

We always think about TIPS in the U.S. context, but TIPS have been trading certainly in Europe and Asia since the early '80s. So, it's actually more of a mature market and a larger market frankly than the U.S. So, from that standpoint we think investors are looking more and more for inflation protection overseas, and when you look at the CPI numbers coming out of Latin America and some of the emerging-market countries, and certainly China, it stands to a reason that's an additional inflation hedge not just gold or silver.

Justice: Well, in our ETFInvestor Hands-Free portfolio, we do own gold and we do own international treasuries that are inflation protected through your WIP product.

Gentlemen, I appreciate your time today in helping people round out their portfolios. Thank you for joining me.

I'm Paul Justice for Morningstar. For this and more ETF information, please check out the ETF Center on and our ETFInvestor newsletter.