How to make the biggest profits from gold and silver

Filed under: Gold & Silver — peterjcooper @ 11:00 am

Investors are being won over to the case for precious metals on a daily basis, and the case against this asset class is also weakening by the day. Time then to consider how to gear up to achieve maximum returns in this asset class, albeit with higher risk.

With the UK’s second largest bank, Royal Bank of Scotland predicting a stock market and credit crash within the next three months, it is hardly surprising that the bank’s latest fund for expatriates has a heavy weighting for gold. The ongoing geopolitical tensions between Israel and Iran are also reason enough for nervous investors to seek refuge in this traditional safe haven asset.

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Royal Bank of Scotland has given gold a 25 per cent weighting in its latest Autopilot capital guaranteed deposit account targeted at UAE expatriate customers. Performance is weighted equally across four sectors: emerging equities, developed equities, property and gold. The new fund will track performance of the four sectors when rising, and divert to cash when a falling trend is identified, so gold could be its sole investment class.

The role of gold in this new account is bound to raise eyebrows and comes as the bank is warning customers to expect turmoil in equity and credit markets over the next three months, an unusal statement for the second largest UK bank. Time indeed for UAE investors to consider a little diversification into precious metals.

This column has recently presented quite a detailed case for investment in gold and silver both on the grounds of the supply and demand imbalance in the market, and because speculative interest is likely to build in an increasingly inflationary global economic environment.

Buying bullion or coins and storing them is one approach. But what if investors want to gear up to achieve maximum leverage against the price movements that seem highly likely in gold and even more so in silver?

The most obvious vehicle is a futures contract. The Dubai Gold & Commodities Exchange has contracts available for gold and silver. They are intended primarily for jewelry manufacturers for hedging price movements but they are equally useful if you want to achieve a considerable level of exposure to precious metals without having to come up with more than a down payment.

The problem with options – when you are not using them to hedge against physical metal actually being delivered on a particular date – is that timing is crucial and very difficult. If you get the timing wrong by as much as a few hours an option can expire worthless, and you will lose the entire deposit.

This is why some professional investors in precious metals choose to avoid options altogether, and instead plump for buying the most risky class of shares in the sector: the junior exploration companies.

These companies are sometimes unjustly likened to dot-com stocks. It is true that the juniors raise and burn cash while they look for gold. But unlike the dot-coms they do actually own valuable assets in the form of exploration concessions. Such land claims will rise exponentially in value during a precioius metals boom, particularly if they are well located, for example near to existing operational mines.

The argument for buying juniors is the same as buying land during a property boom: the value of land claims will soar as a boom takes off. After 1978 in the last great gold boom junior exploration stocks jumped in value with 100 and 1,000 fold increases, and even the firms with the worst claims in poor locations did well.

Creating a portfolio of junior exploration stocks, with a basket of top stock picks, is a sensible approach rather than concentrating into one company. Then if a few turn out to be real duds then the performance of the rest should still deliver a handsome return. There are many specialist websites on the Internet offering good advice on junior exploration stocks, such as www.goldseek.com and www.golddrivers.com.

Another approach to leveraging precious metal prices is to gear up on what should be the outperformance of silver versus gold. So far in the 2000s silver has kept up its tradtional outperformance in a bull market, delivering twice the price appreciation of gold, albeit with greater volatility. This greater performance is a gift for the clever investor in precious metals.

Shares in pure-play silver companies should deliver an even higher performance than the metal itself. It is not hard to see why. Silver producers have relatively fixed production costs so if silver prices rocket then their profits will rise by an even higher percentage. Hence the share price is leveraged to the price of silver.

Again the smallest silver exploration companies may deliver the best absolute returns. But there are some very large pure-play silver companies like Hecla, Pan American Silver, Silver Corp and Silver Wheaton that offer strong leverage to the silver price without the additional risk of a smaller company. For more information there are specialists websites like www.silverseek.com and www.silver-investor.com which can offer more detailed advice on silver.

To conclude, UAE investors looking for an aggressive portfolio in precious metals with maximum leverage to price changes should be looking beyond bullion and coins, and towards investments in junior exploration companies and pure-play silver producers. In the final stages of this boom in gold and silver this is where the best returns will come just as in the late 1970s.