Demand by exchange-traded funds moves metal prices

By Jan McCallum

Gold is likely to first spring to mind when metals are mentioned, yet it is only one metal in an increasingly large selection available to investors.
The options for investing in metals such as platinum, palladium, nickel, silver, aluminium, copper and tin are widening with the launch of exchange traded commodity funds on major world stock markets.

The funds – exchange traded index funds (ETFs) and exchange traded commodity funds (ETCs) - have become so popular that they are now influencing the price of metals traded on world markets and have increased price volatility. 
ETCs invest directly in commodities, buying the physical metal to back their investments, so investors get a stake in a holding of metal in a vault somewhere.  As more investors buy units, the fund buys more of the commodity. 
Exchange traded index funds (ETFs) buy into a share index, with the fund manager buying shares in companies to replicate the index.  The funds are not actively managed since they just attempt to track the index, so the fees tend to be lower than with other managed funds.

There is a wide range of ETFs available on major stock markets, including in shares, property and fixed interest.  The benefit for investors in the metals-based ones is exposure to a commodity without having to physically buy shares or metal, and an investment they can readily trade on an exchange.  In the case of an ETC, the exposure is directly to the price, whereas an exchange-traded share fund will give a stake in various companies with the upside of exploration and production success, but the downside of failure as well.  Such a fund gives diversity to the investor who might otherwise only be able to afford a stake in one company and provides an opportunity in markets where there are a limited number of listed metal producers.

ETC funds have proved so popular that they have been active buyers on commodity markets to the point where they have moved the price of the physical commodity.  Some commentators believe this investment demand has made the gold price more volatile although over the last year there has been renewed interest in gold because of economic uncertainty.

According to the World Gold Council, investment demand for gold rose 46 per cent year-on-year in the second quarter, although overall demand was down.  ETFs bought 57 tonnes, adding to the 465 tonnes they had snapped up in the first quarter.  The funds’ buying outstripped central banks around the world which bought a net 14 tonnes of gold in the second quarter.

ETF activity has also affected other metals.  A report in August by metals trade Johnson Matthey on platinum and palladium found that ETF buying reduced liquidity in the market and increased price volatility, particularly as the metal cannot be loaned out.

Johnson Matthey said two platinum-group ETFs were launched in Europe in 2007 and ETFs accumulated 200,000 ounces that year and another 100,000 ounces in 2008. Total supply in 2008 was 5.27 million ounces.

The report noted that purchases and sales of ETF shares had been highly correlated to movements in the metal price, particularly for platinum. “Investors have bought heavily at times of rising prices, adding to the upward pressure on the price, and sold heavily as the price fell, exacerbating the fall in the platinum price by adding liquidity to the market in the second half of 2008.”

ETF platinum holdings peaked at almost 500,000 ounces in the middle of 2008 before declining to end the year close to the 300,000-ounce level.  As the price recovered this year, ETF investors started buying again and the funds bought another 200,000 ounces, taking their holdings in mid-June to a record level of just over 520,000 ounces. Johnson Matthey noted that new platinum-group ETFs are being launched in Japan and the United States.

The major world markets for trading metals are the London Metals Exchange and the New York Mercantile Exchange (NYMEX) and investors can log onto their websites to track metals prices and read news about demand and supply of the commodities.

Investor demand for metals picked up some of the decrease from manufacturers last year due to the economic slow down.  Silver is used in photography and electronics as well as jewellery and although platinum and palladium are used in jewellery, they and other platinum-group metals are also used in glass manufacture, the auto, electrical and chemical industries.

The prices of metals such as copper, aluminium and nickel are expected to remain subdued this year but pick up in 2010, depending on demand from China and the pace of economic recovery elsewhere.  Some forecasters believe gold will rise further, although it has struggled to hold onto the US$1000 an ounce level.
ETFs will continue to be active in the metals markets as more funds are opened to investors around the world, and metals markets are likely to be more volatile as a result.

Sources:

www.gold.org
www.lme.co.uk
www.nymex.com
www.platinum.matthey.com