Henry Hazlitt once said, “If precious metals had been abundant, they would not have been precious.” This is the point of precious metal trading, a market that has truly proven its mettle (no pun intended).
Investors trade precious metals because they are valuable, especially with worsening economic conditions. They buy them for investment value, wealth preservation and, of course, bragging rights.
Several precious metals are mined globally. However, we generally focus on the ‘Big Four’ (gold, silver, platinum and palladium). This is despite having rarer precious metals like rhodium (the rarest of them all), ruthenium, and osmium.
The Big Four are the most accessible and practical of the lot. So, this article will focus on how to trade precious metals of these kinds.
Trading precious metals: what is it?
It’s all well and good that you wish to be a precious metals trader. But let’s first define a precious metal. A precious or noble metal is a rare, naturally forming substance from the Earth’s crust. Rarity is one of the standard features of these commodities, making them difficult to mine.
Because they generate massive demand, they have much higher economic value than other common or base metals like iron, lead and copper. Unlike their counterparts, precious metals in their natural state technically don’t rust.
Also, they have a lustrous texture, another factor contributing to their high-value social and economic status. These are the main reasons we trade precious metals. However, what do we use these commodities for? Let’s take a look.
Although gold is not the rarest or priciest metal, it is the most revered. Heck, we even had a gold standard at some point in history. The world has been fascinated with trading metals in gold form since the beginning of civilization.
Gold has several favorable qualities which make it a highly desirable metal. It:
- Conducts heat and electricity well
- Is very ductile or pliable (an ounce can be stretched into 80 km of gold wire)
- Is reflective of heat and light
Last but not least, gold, this metal is simply beautiful. Whether you emboss, hammer, twist or cast it, its orange-yellow colour remains appealing. Here is a sample of the industries where gold is used:
Silver is, of course, not a particularly rare commodity when we want to trade precious metals. Still, it is the second-most popular commodity after gold and has many practical benefits. Like gold, silver is ductile, durable, corrosion-resistant and lustrous.
Yet, what sets silver apart is that it has the greatest thermal and electrical conductivity among all metals. Here are a few of the practical applications of this commodity:
- Mechanical or vehicle parts
Few people think of platinum when they trade precious metals. Yet, it is the second-rarest of the lot, with roughly 90% of this commodity found only in South Africa.
Platinum is sometimes referred to as ‘white gold’, given its silverish-white appearance. Not only that, this commodity possesses outstanding economic value, like gold. Platinum is very unreactive, ductile, and soft, resulting in numerous industrial uses:
Palladium is another rarely-mentioned commodity when it comes to precious metal traders. While it is less scarce than gold and platinum, it is slightly rarer than silver. It is a soft silver-white metal that resembles platinum and shares many characteristics.
Interestingly, over 50% of palladium’s supply is used for exhaust emissions controls in automotive industries. Here are some of the metal’s other usages:
- Groundwater treatment
- Chemical applications
- Hydrogen purification
The different ways to trade precious metals
There are generally three methods to trading metals. Before we dive into them in more detail, the table below summarises the pros/cons for each.
|Bullion trading||– Physical and pure ownership- No counterparty risk- May be useful in hyperinflation scenarios and wealth preservation- Simpler to understand-||– Very expensive- Not liquid- Storage costs apply- Bulky- Doesn’t provide any yield|
|Mutual/exchange-traded funds||– Online-traded- Best for passive investing- Diversification- Lower fees||– Only suitable for long-term investors- Reduced profit yields|
|Derivatives||– Online-traded- Leveraged product- More accessible- No physical ownership of the asset- Potential for the most gains- Very liquid||– Over-leveraging can result in massive losses- More complex to understand|
Here, we typically refer to gold and silver in nearly 100%-pure bar form. However, you can also purchase platinum and palladium as bars as well. Central banks popularly hold bullion to settle their international debt.
Investors also keep it in case of potential hyperinflation events. Precious metal traders consider this route the purest way to own this commodity. The primary reason is there are no ties to any third-party financial system like a bank, broker or exchange. So, there is no counterparty risk.
On the downside, bullion trading isn’t technically an investment. Thus it doesn’t offer any passive income because it is used more as an inflationary hedge. Of course, it is also very expensive, requires extra costly storage and is challenging to resell.
The other alternative bullion trading is rare and collectable coins owned by private dealers. This is perhaps the most investment-worthy approach to trade precious metals in their physical form.
Unlike bullion, it is less bulky and typically doesn’t need elaborate storage. However, rare coins are also quite costly and difficult to resell.
The next approach to trade precious metals is through mutual funds or ETFs (exchange-traded funds). Although these have some distinctions, the common theme is that each is an index of other metal-related instruments.
For instance, the abrdn Physical Precious Metals Basket Shares ETF (GLTR) is an index to trade precious metals. It is based on the prices of gold, silver, platinum and palladium bullion collectively. Yet, the majority of funds for precious metals track the price of gold and silver. There are fewer individual ones for platinum and palladium.
The first purpose of funds is easier diversification. For instance, the GLTR contains four metals in one, meaning you don’t need to invest in each market individually. The second benefit of funds, primarily ETFs, is they are designed for long-term investing.
Like derivatives (which we’ll cover next), we trade funds online, meaning there is no need to own any commodity physically.
On the downside, because funds are passive and long-term in nature, you typically generate less profit when you trade precious metals in this fashion compared to derivatives.
Let’s now cover the most popular and accessible avenue to trade precious metals. A derivative is an online-traded financial contract whose value is taken or derived from an underlying asset. For instance, the XAU/USD forex pair is the price of gold against the US dollar.
As with funds, we don’t own the traded physical asset. Instead, the broker settles the difference by crediting your account (if the position is profitable) or debiting it (if it is a loss). This is also why a derivative is called a CFD, contract for difference.
The most outstanding feature of derivatives is leverage or margin. This simply means you can open far larger positions with a smaller balance. Therefore, derivatives can provide the most significant returns in precious metals trading in a relatively short period (but also the worst losses).
The next advantage of derivatives is they are very liquid. This means you can buy and sell in seconds, which isn’t possible with physical ownership. Lastly, derivatives suit all time-frames of trading, from short-term to long-term.
Overall, it is arguably the best way to trade precious metals.
The longevity of any financial market lies in its real-world practicality. Aside from the beauty aspect, precious metals trading is a component of many industrial usages. This means there will always be demand for gold, silver, platinum and palladium.
The perception of these commodities being safe havens and storers of value remains, although this has been challenged in the last few decades. However, you don’t have to only trade precious metals; they can form part of your diversified portfolio.
Our final point is that the metals trading market can be quite volatile, as with any financial security. So, keep this in mind and invest cautiously.