Precious metals have many downsides for stock portfolios

By John Waggoner, USA TODAY

Your body needs certain essential minerals. Calcium keeps your bones strong. Iron is good for the blood. Uranium isn't good for you, but it does make you glow in the dark, which ought to count for something.

You can make the argument that some precious metals are good for your portfolio. Gold, for example, can help hedge against the devaluation of paper currency. Silver can do the same job, at a fraction of the cost.

But do you need copper in your portfolio? Palladium? How about cerium, manganese, titanium and tungsten? Probably not. And, while there are funds that invest in all of these metals, they probably won't do much good for your portfolio.

The fund industry has been pumping out metals-based exchange traded funds (ETFs) and exchange traded notes (ETNs) at a frenetic pace this year. At least 22 precious metals funds have made their debut this year. And, if you want more exotic precious metals, you can buy the ETFS Physical Platinum Shares (ticker: PPLT) or the ETFS Physical Palladium Shares (PALL).

Precious metals too fancy for you? Try a fund that specializes in industrial metals. IPath, for example, has rolled out ETNs that reflect the price of aluminum, copper, lead and tin. PowerShares has ETFs that will let you invest in a basket of industrial metals.


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The Van Eck funds introduced the Rare Earth/Strategic Metals fund this week (REMX), which invests in the stock of companies that mine minerals such as dysprosium (good for lasers and hard drives) and europium (television screens and fluorescent lamps). China provides about 95% of the world's rare-earth elements.

From a contrarian point of view, there are two reasons to be wary of new metals funds. First is the desperation effect, which occurs in bull markets of all sorts: As mainstream investments rise in price, investors start pushing up the prices of more esoteric investments.

A good example: emerging markets. As stock prices in well-known emerging markets have risen — such as India, up 29.3% this year, according to MSCI/Barra— investors have started putting their money in cheaper and lesser-known frontier markets, such as Estonia (+50.2% ) and Argentina (+60%). By the top of the emerging markets cycle, people will be giving money to penguins in Antarctica.

The interest in platinum, palladium and dysprosium is somewhat similar. Gold has risen 21.2% this year, primarily for monetary reasons: People are worried about the falling value of the U.S. dollar.

So it's not surprising that other metals have gained, too, albeit for different reasons. Nickel has risen 24% this year, according to Bloomberg, while palladium has gained 59%. (Both markets have been driven by growth in China. Nickel is useful in stainless steel and batteries, while palladium is used in catalytic converters.) Prices of some rare-earth metals have soared because of China's recent shutoff of supplies.

The second reason to be wary of today's new metals funds is that you should always be suspicious of any newly popular type of fund. Typically, fund companies launch new funds late in the game, because it takes months to spot a trend, start the fund and get it approved by the Securities and Exchange Commission for sale to the public. By that time, the investment trend has faded.

A few funds invest directly in actual metals, and that, too, can be problematic. Although there's plenty of gold and silver for funds to buy, platinum and palladium supplies are relatively scant, and the funds' own buying and selling could affect the market for these metals.

Bear in mind, too, that gains from ETFs that invest directly in metals are taxed at 28%, vs. 15% for stocks. Metals funds that don't buy the metal itself fall into three categories:

•Futures funds. These funds buy futures contracts to mirror the price of the metal. The mechanics of buying these contracts, however, can lead to considerable drag on the fund's performance. (Gains from these funds are taxed at a blended rate of 60% long-term capital gains and 40% short-term capital gains.)

•Exchange traded notes. These are actually long-term debts issued by banks; the returns from the notes track an index that tracks the actual metal.

•Stock funds. These invest in the stocks of companies that mine metals; the Van Eck offering is an example of this, as are most gold funds.

Unless you're a die-hard speculator or a knowledgeable mining company employee, you should avoid funds that specialize in individual industrial metals. A more rational approach would be to invest in a broadly diversified basket of commodities — although sparingly. The commodities market can be exceptionally volatile. Most people have all the metals they need in their body. There's no need to add them to your portfolio.

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