5 Reasons why sophisticated investors are investing in metal ETFs.

Billions of dollars have been poured into metal ETFs over the past few years. There are a number of reasons savvy investors are bullish on the sector:

1. Strong economic growth in emerging markets. Metals such as steel and nickel are a critical base material for many industries, including construction, shipping, automotive and capital machinery. Developing countries such as India and China are industrializing rapidly and will need metals to fuel their booming economies. Buying metal ETFs is a good way to make a play on this huge trend.

2. Volatility. Metals are primarily used in expensive capital goods such as buildings, cars, and ships. The demand for these types of goods closely follows the economic cycle. The mining and processing of metal is very competitive as the good is a commodity. This makes the pricing very volatile. Whether this is a good or bad thing depends of what type of investor you are. There is a lot of profit opportunity for savvy investors who have a tolerance for risk. Conservative investors however should be wary of allocating a significant sum of their savings to this category.

3. Portfolio Diversification. The prices of commodities  are somewhat uncorrelated with stocks and bonds. Because of this, they act as a hedge against financial volatility and inflation.

4. The ETF advantage. Before the introduction of ETFs, investors used to have buy the stock of individual mining companies. Since these firms usually have large reserves of the metal, their shares are affected by the fluctuation of global metal prices. But individual stocks are also affected by issues specific to the company. For example, United States Steel (X) is also greatly affected by its relations with the steel worker’s union.

ETFs are composed of dozens of companies and thus these individual issues are less important . Replicating this with individual stocks would be very expensive. ETFs can be bought and sold for under $10.

Many metal companies use hedging strategies to stabilize their revenue. This somewhat insulates their share prices from fluctuations in prices. Investors looking for a more “pure” way to bet on metal prices can look into ETFs that are composed of future contracts.

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