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Precious metals indexes track the performance of a basket of precious metals or stocks of companies in the precious metals industry. They can be easily accessed and traded on an exchange, allowing investors to diversify their portfolios without owning physical metals. Commodity index mutual funds and exchange-traded notes are popular ways to invest in this market.
A precious metals index is a financial instrument that serves as a benchmark for a basket of certain precious metals, such as gold, silver, platinum, and palladium. You can also list stocks of companies that are in the precious metals industry, such as mining companies. A notable one is the S&P GSCI Precious Metals Index (S&P PMI) which consists of gold and silver. An example of one that tracks stocks would be the Dow Jones Precious Metals Index (DJPMI), which is made up of companies in the mining and precious metals sub-sectors. By design, a precious metals index can be easily accessed through various means and traded on an exchange from large investors with colossal funds to small private traders with a small amount to invest.
Those in the commodity trading business, for example, may actively trade an index like the S&P PMI rather than dabble in gold trading or silver trading individually. The S&P PMI measurement is based on physical gold and silver, which are underlying assets that are actively traded on the futures market. The futures market is where commodity contracts are traded for future delivery. The dollar weight of each precious metal in the S&P PMI is roughly proportional to its quantity and value of average global production, based on available data for the past five years. This weight represents the relative importance of each metal in the global economy while allowing the index to trade as expected.
Investors can diversify their portfolios by investing in precious metals, and an index like the DJPMI is one way to enable them to do this. The DJPMI reflects the performance of US-traded shares of companies that explore for and produce gold, silver, and platinum. In 2010, for example, there were 12 component actions that made up the DJPMI. Inclusion of stocks in the index is subject to a strict criteria test.
It can be an onerous task to own physical precious metals, because the costs associated with doing so can be great. Therefore, most investors prefer to gain access to this asset class through an index, among other ways. In this way, they achieve their diversification goals without owning the physical metals.
Using a commodity index mutual fund is one way investors gain exposure to this market. Another way to reach the market is through exchange-traded notes (ETNs). ETNs, in this case, are some type of debt securities issued by a company, and are linked to the performance of an index of precious metals. This connection and other factors will generate positive or negative results for an investor who has purchased them for their portfolio. For example, an ETN issuer may be downgraded and/or defaulted, which may adversely affect the value of an investor’s investment.
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