Season Investments


Micro Update: White Metals

Posted on February 8, 2012


Commodities can be classified into 3 major categories: energy, metals, & agriculture. Metal commodities can be further broken down into either industrial or precious metals. The differentiating factor between the two metal types is the source of demand and their rarity. Industrial metals are mined in large quantities every year and have a plethora of industrial uses, which is the main source of demand. Although many precious metals have industrial uses as well, there is additional demand from jewelry and investment since their scarcity makes them a good store of value. The most common precious metals are gold, silver, and the platinum group metals (PGM). At Season Investments, we take the differentiation a step further by stripping gold out of the commodities asset class and treating it as a currency since it trades like a currency and has very little to no industrial use (something all other commodities possess). This leaves us with the “white metals” of silver and PGM in the precious metals sub-category. We are currently overweight the white metals in our commodity allocation through a physically backed ETF with the ticker WITE. 

In the past, precious metals have been an excellent store of value and are considered to be on the more defensive end of the commodity risk spectrum. They tend to outperform the broader commodity complex when real interest rates (e.g. market interest rate – annual rate of inflation) are low, since the opportunity cost of holding precious metals over other defensive assets like bonds is low. In today’s financially repressed market where the Fed is forcing “grandma to subsidize Goldman” with artificially low interest rates, real rates are actually negative making it an ideal environment for precious metals. Another tailwind for precious metals has been the general debasement of fiat (e.g. paper) currencies with central banks around the world firing up the printing presses to juice economic growth and finance government spending. Increasing the money supply via the printing press debases a fiat currency and increases the price of “stuff” denominated in that currency, such as commodities and precious metals in particular. We don’t see this tailwind dying down anytime soon with the massive amount of outstanding global debt that will most likely be monetized through this process. 

In addition to these macro tailwinds, there are other micro factors that influenced our decision to invest in the white metals complex. Commodities are very cyclical in nature and as such tend to be very volatile. PLAT-GOLD_small.jpgOften times, the best time to invest in an individual commodity or sub-category is when it has been beaten up and severely lagged other commodities. At the beginning of the year, silver was down 50% from its 2011 peak, the gold to silver ratio was at a 12 month high (silver cheap compared to gold), and the platinum to gold ratio was at a multi-decade low (platinum cheap compared to gold). Most of this underperformance was due to the scare in 2011 of a global recession as Europe dealt (and continues to deal) with a massive debt problem and Emerging Markets tried to cool off their overheating economies. Time will tell if this scare becomes a reality, but entering a position after some of these risks have already been PLAT-GOLD_small.jpg“priced in” provides a better margin of safety then buying when everything looks rosy. Other catalysts for platinum in particular come from the high and rising costs of mining the metal in South Africa, which accounts for over three quarters of the global output. If demand remains firm while supply is reduced, there will be upward pressure on prices. 

The largest risk to this investment, as with all risk assets, is the potential for a major, global economic slowdown brought about by a disorderly European default or some other presently unkown factor. On a more micro level, silver does not share the same fundamental tailwinds as platinum and the market is considered to be “oversupplied” at the moment which could keep a lid on the price. In summary, our decision to overweight the precious metals complex within the commodity asset class came down to the current market environment as well as a “mean reversion trade” stemming from the relative underperformance of white metals versus other commodities over the past 6 months.

We want Transparency to be one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. Regular Macro Updates will address our economic and capital market viewpoints and discuss top-down portfolio positioning. Also watch for Micro Updates which convey our reasoning behind specific investments.

This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.