What is a Precious Metals Index?

Justin Riche

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. It can also comprise a list of 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 its design, a precious metals index can be easily accessed through various means and traded on an exchange by large investors with colossal funds to small private traders with a little amount to invest.

Palladium is an investment commodity.
Palladium is an investment commodity.

Those in the commodities trading business, for example, can actively trade an index such as the S&P PMI instead of dabbling in gold trading or silver trading individually. The measurement of the S&P PMI is based on the physical gold and silver, that are underlying assets actively traded in the futures market. The futures market is where contracts of commodities are traded for future delivery. The dollar weight of each precious metal in the S&P PMI is more or less proportionate with its average world production quantity and value, according to the previous five years of data available. This weight represents the relative significance of each metal in the global economy while allowing the index to be traded as intended.

Stack of gold bars.
Stack of gold bars.

Investors can diversify their portfolios by making precious metals investments, and an index such as the DJPMI is one way that allow them this venture. The DJPMI reflects the performance of U.S. traded stocks of the companies that explore and produce gold, silver and platinum. In 2010, for example, there were 12 component stocks making up the DJPMI. The inclusion of stocks in the index is subject to a stringent criteria test.

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It can be a burdensome task to own physical precious metals, because the costs associated with this can be great. Therefore, most investors prefer to gain access to this asset class through an index, among other ways. This way, they achieve their diversification goals without owning the physical metals.

Using a commodity-indexed mutual fund is one way that investors obtain exposure to this market. Another way of reaching the market is through exchange-traded notes (ETNs). ETNs, in this instance, are some type of debt securities issued by a firm, and they are tied to the performance of a precious metals index. This connection, and other factors, will spawn either positive or negative results for an investor who acquired them for his or her portfolio. For example, an ETN issuer might be downgraded and/or default, which can adversely affect the value of an investor's investment.

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