ETF Spotlight: March 2011

Published on by on March 1, 2011

Each month, we highlight an ETF flying under the radar of most investors that offers exposure to a unique asset class or investment strategies. This month, we take a closer look at a commodity-producers fund from Global X that offers a compelling way for investors to achieve silver exposure: the Global X Silver Miners (SIL).

The new year continues to shock and amaze investors of all walks. Tensions in the Middle East are continuing to escalate with violent uprisings breaking out in Libya and Iran, and political instability in Egypt has not been quelled by any means. As a result, domestic and foreign equities have been cautiously advancing, however, volatility and uncertainty are still the major themes that dominate global financial markets. Traditional safehavens like U.S. Treasuries and gold, which recently regained its footing above $1,400 an ounce, are attracting more and more investors, as the equity market further advances into overbought territory. With the global economic recovery still progressing rather slowly, there are fewer “safe” opportunities available to those with a longer-term investment horizon.

Gold, the most well known precious metal around the world, is typically seen as the pinnacle of safe-haven investing. The shiny yellow metal has historically been considered as the ultimate inflation hedge, and more often than not it has served as a psychological safehaven for traders and investors alike in times of uncertainty. Recent political instability in the Middle East and ongoing fears of a weakening U.S. dollar have sent gold prices surging. Only recently did the hot yellow metal take a brake from its upward run, but with growing economic uncertainty and violence overseas, it seems that the precious metal is once again back on track and climbing higher.

The ongoing surge in gold is making some investors worrisome that the yellow metal might be due for a significant pullback. However, those who tend to wait too long usually get left behind. While it may be the case that gold still has tremendous potential for upside, investing in silver is also a viable strategy that ought to be considered. Silver is much more volatile than gold, and thus it tends to outperform gold when it rises, just as it is known to fall harder and faster when its yellow cousin is slumping.

Silver is not merely a leveraged play on gold, as this precious metal has numerous other advantages over its more expensive yellow counterpart. This precious metal not only mimics the safehaven traits of gold, in serving as a hedge against inflation, market volatility, and geopolitical tensions,  its demand is actually primarily driven by industry. In fact, 54% of silver demand is industrial, more specifically the precious metal is used in electronics, as a catalyst in many chemical processes, optics,  jewelry, dentistry, household goods, and numerous other sectors. BMO Capital Markets is forecasting industrial demand for silver to rise 19% in 2011, and furthermore silver jewelery demand in developed and emerging markets is likely to increase as discretionary income improves for many consumers.

Much like any investment strategy, investors typically have multiple products available to choose from. When it comes to investing in precious metals, opting to buy mining companies is a viable alternative to investing in an index that tracks the price of a given commodity. With respect to silver, investors ought to consider taking a closer look at SIL. This exchange-traded fund tracks the Solactive Global Silver Miners Index, which is designed to reflect the performance of the silver mining industry. It is comprised of common stocks, ADRs and GDRs of selected companies globally that are actively engaged in some aspect of the silver mining industry such as silver mining, refining or exploration.

Investing in mining companies allows for more leveraged exposure to the desired commodity. Since mining companies have relatively fixed-costs in terms of their operations, a rise in the price of silver will greatly increase their profitability. Likewise, if the price of silver declines, the leveraged exposure will unfavorably work against you.

SIL has a total of 29 holdings, and they are relatively equally split between large, mid, and small-cap silver mining companies. In terms of geographic diversification, the funds holdings are primarily in developed countries (Canada, US), while only a quarter are located in emerging markets (Mexico, Peru). Over the last 52 weeks the fund has returned close to 70%, and while investors shouldn’t expect for this kind of stellar performance to continue, SIL is still a good choice for those looking to diversify their portfolios with commodity exposure. Given the historically low correlation that commodities exhibit when compared with stocks/bonds, adding precious metal exposure to your portfolio may be a great way to reduce overall volatility and enhance risk-adjusted returns.

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