Achieve Diversification Through Precious Metals

Investing in precious metals like gold, silver, platinum, and palladium has long been a trusted strategy for diversifying investment portfolios and hedging against market volatility.

While stocks, bonds, and cash make up most investors' core holdings, exposing precious metals can provide unique benefits that complement other assets.

In this article, you'll understand why precious metals deserve an allocation in your investment portfolio and their historical performance in different market cycles.

Fundamentals Behind Precious Metals Prices

Gold and silver have intrinsic value because of their rarity, uniqueness, and physical properties. Their use as monetary assets and value storage goes back thousands of years.

Today, gold and silver have industrial applications, including electronics fabrication and medical devices, but investment and jewellery demand are the primary price drivers.

Gold and silver supplies are limited and sourced from mining production, recycling, and official sector sales. Above-ground supplies accumulate over time.

Platinum and palladium are much smaller markets centred around automotive catalyst demand. Over 80% of platinum is used in catalytic converters in diesel vehicles and other industrial applications, while palladium is used mainly in catalytic converters for gasoline vehicles.

Limited supplies and sources of demand create scarcity, which supports the prices of precious metals over time. Scarcity and strong demand make precious metals less responsive to new supply than other commodities.

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How Precious Metals Can Diversify Your Portfolio

Now let's examine the four main ways precious metals can provide diversification benefits for an investment portfolio:

1. Low correlation to stocks and bonds
2. Inflation hedge
3. Currency hedge
4. Crisis hedge

The basic premise behind portfolio diversification is a low or negative correlation between stocks and bonds. When stock and bond prices decline, uncorrelated assets can hold their value or even appreciate, smoothing out volatility over time.

Precious metals have historically had negative or low correlations to stocks and bonds. Looking at rolling 5-year correlations to the S&P 500 from 1987, gold has averaged just 0.13. Silver averaged 0.29, platinum 0.15, and palladium 0.44.

Periods of high inflation or market turmoil have seen these correlations go even lower or turn negative. Adding any precious metals to a stock and bond portfolio increases its diversification.

Inflation hedge ability is also vital. Rising inflation erodes the purchasing power of cash, and stocks and bonds are also vulnerable to high inflation surprises. On the other hand, the prices of precious metals tend to rise during high or unexpected inflation due to their intrinsic value and scarcity.

When used as a currency hedge, precious metals help protect against devaluation. During periods of U.S. dollar weakness, Dollar-priced commodities like gold can be appreciated to offset losses in the domestic currency. This is true for short U.S. dollar cycles and long-term declines.

Finally, in periods of severe crisis or market panic, the prices of precious metals often benefit from a "flight to safety" boost. Their role as resilient crisis hedges comes from being tangible assets with little counterparty risk. This was seen during the 2008 financial crisis when precious metals strongly outperformed stocks.

In short, adding precious metal exposure to a portfolio provides non-correlated returns, inflation protection, currency hedging, and crisis resilience. This diversification can smooth out risk and preserve wealth over the long term.

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Historical Performance Through Different Market Cycles

Precious metals have demonstrated their diversification benefits throughout history. Let's look at how they have performed in different market environments:

Inflation Hedge in the 1970s

The 1970s were characterized by severe stagflation, with average annual CPI rising over 7% by the decade's end. As inflation surged, gold prices rose from $38 per ounce in 1970 to over $800 by 1980, gaining over 2000%.

Silver also rallied strongly, going from $1.50 to nearly $50 over the decade, a gain of over 3000%. Gold and silver served as excellent inflation hedges and diversifiers through this crisis decade.

Safe Haven in the 2000s Deflation and the 2008 Financial Crisis

After peaking in 1980, precious metals declined for much of the next 20 years as inflation slowed. However, as we entered the 2000s, they began to rise again slowly, then accelerated into the 2008 financial crisis.

From 2000 to 2011, Gold prices rose 540% from $280 to a peak of $1900. Silver gained 720% from $4.30 to $48. This demonstrated the precious metals' weakness during the U.S. dollar and market turmoil, even when inflation was not rising.

The 2010s Bull Market Divergence

Coming out of the financial crisis, the Fed launched quantitative easing and took interest rates to zero, helping fuel a massive bull market in stocks through the 2010s. With ample liquidity, stocks diverged from precious metals.

Gold and silver trended down for much of the decade, while platinum fell over 50%. This period showed that precious metals tend to underperform when stocks rise smoothly in a low-inflation environment. Still, maintaining an allocation to precious metals helped cushion downside risk when periodic corrections hit the stock market.

In conclusion,

Precious metals like gold, silver, platinum, and palladium deserve consideration in any well-diversified investment portfolio. Their unique properties and diverse demand drivers help them hedge various market risks.

With proven historical performance as an inflation hedge, crisis hedge, and portfolio diversifier, precious metals can provide non-correlated returns over the long term.

Traders should continue researching precious metal markets and price dynamics to understand better how they can contribute to investment goals.

Maintaining a small portion of a portfolio in physical precious metals or related securities can enhance returns while mitigating risks across changing economic cycles.

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“When considering “CFDs” for trading and price predictions, remember that trading CFDs involves a significant risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be considered investment advice.”