The High Price of Precious Metals

Precious metals prices are like the weather. There are plenty of forecasts and only a few accurate predictions.

But even the most oblivious investor can tell which way the wind has been blowing lately. Prices of gold, silver and platinum have soared for more than seven years. Since 2001, gold has risen 248%, from $271 per ounce to $945 on February 22; silver has gained 290%, from $5 per ounce to $18; and platinum has jumped 256%, from $610 per ounce to $2,165. Since January, gold and platinum have regularly been setting new highs, surpassing prices last seen in 1980.

There are explanations aplenty for the boom. The decline of the U.S. dollar, geopolitical uncertainty and the growing demand for bling from residents of increasingly prosperous emerging markets are the obvious culprits. Investors perceive gold and, to a lesser extent, other precious metals to have inherent value against the devaluation of paper money. Gold is bought and sold in dollars, so any decline in the value of the dollar causes the gold prices to rise.

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Fear feeds into precious metals prices, particularly moves in gold. The international credit crisis, worries of stagflation and a slide in U.S. consumer spending and home prices have frightened many investors. Concerns about developments in places like Afghanistan, Iran and Venezuela also weigh on investors.

"In this environment, investors have put a very high risk premium on to precious metals," says Jeffrey Christian, managing director of CPM Group, a commodities research firm. "At some point, they will grow less fearsome of the financial, economic and political world around them. At that point, precious metals prices will decline."

That said, Christian says prices will remain high for some time and possibly move higher. But he worries about the large sums of borrowed money used by institutional investors, such as hedge funds, to buy precious metals. If those positions unwind, that could cause a steep decline in prices.

Recent hiccups in the platinum supply have caused prices to spike. Platinum prices surpassed $2,000 an ounce for the first time in February after news of mining disruptions in South Africa because of electric power shortages.

A small breakdown in supply can have major repercussions because it takes ten tons of ore and a five-month process to produce a single ounce of platinum. But Frank Holmes, co-manager of the U.S. Global Investors Gold and Precious Metals fund (symbol USERX), thinks those high platinum prices are temporary and will fall as South Africa quickly resolves its power problems.

The continued weakening of the dollar and signs that inflation is accelerating create an environment in which gold tends to perform well, says Charles Ober, manager of the T. Rowe Price New Era (PRNEX), one of our favorite natural-resources funds. "If you look at the history, gold has been a very dramatically under-performing asset class," Ober says. "You can make the argument that gold has got a lot of room to catch up."

Precious metals are prone to wild price swings. Historically, they have been subject to long cycles of boom and bust. Precious metals reached previous highs in 1980, then plunged and languished at low levels for two decades, with only brief periods of gains.

Don't put more than 5% of your portfolio in precious metals. And forget buying bars, bullion and coins of gold, silver and platinum. Such a setup means you need a safe place to store the metals and to insure your stash.

Exchange-traded funds offer the best way to invest in precious metals. StreetTracks Gold Shares (GLD) and iShares Comex Gold Trust (IAU) trade for about one-tenth the price of gold bullion per share. Because ETFs trade like stocks, it's best to go with StreetTracks, which has 35 times the average trading volume of iShares.

If you want silver, too, buy iShares Silver Trust (SLV). The shares trade for ten times the price of silver. The shares of these ETFs represent a stake in gold or silver bullion held in a vault, so you can skip building your own Fort Knox.

Investing in platinum is trickier. You won't find a platinum ETF on any U.S. stock exchange. However, ETF Securities offers a platinum exchange-traded fund that trades under the symbol PHPT on the London Stock Exchange.

The truly adventurous can buy shares of the two largest platinum producers, Anglo Platinum and Impala Platinum. American depositary receipts of Anglo (AGPPY) and Impala (IMPUY) are quoted on the Pink Sheets.

But the stock appreciation of the producers has lagged the gains from platinum itself. You're better off just sticking with gold and silver than going through the trouble of messing with platinum.

It's best to buy precious-metals stocks and funds and the metals themselves on dips. Christian expects a short, severe dip in prices in early March as metals traders roll forward their futures contracts. He also says precious metals will have a period of relative tranquility from May through August if no major geopolitical event affects supply.

If you already own a stake in precious metals, check your portfolio and lock in some gains. The price run-ups may mean it's time to rebalance. See if your precious metals holdings have strayed from your original allocations by a few percentage points or more. If so, trim your precious-metals positions and deploy the proceeds elsewhere.