Precious-metals equities found to strengthen portfolios

While recent volatility in the equity markets and the falling dollar have caused a flight to commodities, new research has found that portfolio performance can be substantially improved when a large portion of a portfolio is reallocated to the equities of precious-metals firms, according to a working paper awaiting publication by the CFA Institute, a group of chartered financial analysts.

The report, titled “Can Precious Metals Make Your Portfolio Shine?”, found that if an investor were to allocate 25% of a portfolio to precious metals, annual returns would be increased by 1.65%, based on data compiled between January 1973 and December 2006.

“I don’t think that people will get too excited about the return differences,” said Robert R. Johnson, deputy chief executive of the CFA Institute in Charlottesville, Va. “Investors should realize that most of the benefits from investing in equities of precious metals come from improved risk reduction.”

The report also noted that the investment benefits are “considerably larger” if the exposure to precious metals is obtained from an investment in the equities in precious-metals firms, rather than by directly purchasing the metals as a commodity. However, the report’s results are contrary to the strategy employed by Theresa Gusman, head of global commodities and managing director at DWS Scudder, the U.S. retail division of Deutsche Asset Management, a subsidiary of Deutsche Bank AG of Frankfurt, Germany.

“At present, we would prefer to be overweight gold rather than gold stocks because gold companies have been bad at forecasting what their production and costs will be,” she said. “They have been producing less gold at higher costs than they initially thought they would.”

Ms. Gusman, the portfolio manager of the DWS Commodity Securities Fund (SKNRX), compared the value of the streetTRACKS Gold Trust ETF (GLD), which has increased 81% since Sept. 1, 2005, compared with Barrick Gold Corp. (ABX) of Toronto and Newmont Mining Corp. (NEM) of Denver, which increased 49% and 25%, respectively, as of last Thursday.

“Our portfolio is a combination of commodities and commodity-related stocks. At present, we believe gold should outperform other commodities because gold is viewed as a store of value and usually performs well during periods of systemic risk,” Ms. Gusman said.

During restrictive periods when the Federal Reserve raised rates, the precious-metals commodities generated returns of 13.29%. Precious-metals equities increased 11.6% at times of expansive Fed policy, while U.S. equities only increased 3.87% during those periods.

“Precious metals perform better than other equities during restrictive periods,” said Mr. Johnson. “Precious metals [equities] still underperform the commodity because it is not a pure play on the commodity.”

“Generally, all equities are negatively impacted by restrictive Fed monetary policy, but metals equities are not affected as much due to the positive influence of the commodity price,” Mr. Johnson said.

U.S. equities and precious-metals equities rose 16.25% and 16.41% during expansive periods, respectively. Meanwhile, precious-metals commodities only rose 4.56% during expansive periods.

One money manager likes commodities as a hedge against precious-metals equities themselves.

“I like the concept of having an allocation to commodities in one’s portfolio rather than taking the basket approach,” said Thomas K.R. Wilson, managing director of institutional investments at Brinker Capital Inc., a Berwyn, Pa.-based investment management firm that manages $9 billion.

Mr. Wilson added that he cautions investors against buying a company that produces a particular commodity that isn’t a direct play on the underlying commodity.

Aaron Siegel can be reached at [email protected].