I’ve long been a believer that, for those few with the intestinal fortitude, a precious metals and mining fund can be a small part of one’s portfolio. Since the late ’90s, the Vanguard Precious Metals and Mining Fund (VGPMX) has been a part of my portfolio.
The extreme volatility and low correlation to stocks add diversification, and rebalancing maximizes gains from those chasing performance. I’ve written on the contrarian case for precious metals and mining as well as warned against it after surges. It’s all about volatility.
But now I’m recommending the VanEck Gold Miners ETF (GDX) for those who want this exposure.
That’s because Vanguard recently came out with an announcement that it is changing the name of its fund to the Vanguard Global Capital Cycles Fund and now only needs to hold 25% of its portfolio in precious metals and mining stocks. It also upped its expense ratio a tad from 0.36% annually to 0.37%.
Why I Disagree
I’m not a big fan of bailing on a fund or a strategy after poor performance, which is what Vanguard is doing.
Its new strategy is following cyclical patterns, looking for companies that are in a period of low demand, and offering stocks that are therefore available at lower prices, with the potential for growth as demand rebounds.
Frankly, this sounds like every other active strategy I’ve heard of. Cycles disappear when discovered. Still, what I particularly dislike about the new strategy is the following:
- Lowering its risk and volatility by adding more diversification
- Improving the consistency of its long-term performance as compared with its benchmark
While these two things sound great, they defeat the purpose of why they are in my portfolio to begin with. The high volatility is one of two ingredients that make it so valuable as a small part of a portfolio. The other ingredient is low correlation to stocks, which Vanguard shows as a 0.02 correlation over the past three years.
I ran this by financial theorist and author William Bernstein, who said, “In the long run, the high volatility of pure precious metals equity (PME) produces ‘volatility pumping,’ the excess return resultant from rebalancing discipline. Over the past four decades, for example, gold bullion, which has a lower volatility, has had a higher return than PME, and yet a small PME allocation produced a better portfolio outcome than an allocation to bullion.”
A Vanguard spokesperson noted that part of the reason for the change was that the precious metals and mining industry group presents a limited investment pool—it’s currently less than 2% of the global market cap.
Well, if the problem is that too much money was chasing that small part of the market, then it sure hasn’t shown up in market gains.
I questioned Vanguard on these points, and it said that, while it agreed adding asset classes with less- than-perfect correlations will lead to greater diversification at the portfolio level, it could be misused by some investors.
Indeed, Morningstar shows that, over the past 15 years, investor returns have lagged fund returns by nearly 3 percentage points (300 basis points) annually. This is a clear sign of performance chasing. Regarding the point that the segment is only 2% of the global market, Vanguard noted it made liquidity more challenging.
VanEck Gold Miners ETF
The VanEck Vectors Gold Miners ETF (GDX) seeks to replicate, before fees and expenses, the price and yield performance of the NYSE Arca Gold Miners Index (GDMNTR), which is intended to track the overall performance of companies involved in the gold mining industry.
The expense ratio is higher, at 0.53% annually, and many times higher than any other fund I recommend. It’s been as volatile as VGPMX and also has low correlations to stocks.
My First Move Of This Kind
This is a big step for me, because, while I own non-Vanguard funds, it represents the first time I have moved from a Vanguard fund to a non-Vanguard fund.
Though the expense ratio of GDX is far higher than I’d like, I don’t see a better play in precious metals and mining. I could own the gold itself with the SPDR Gold Trust (GLD), but it’s not volatile enough, as GLD has a 10-year 18.47% standard deviation versus VGPMX’s at 33.61%, according to Morningstar. Further, GLD is a pure commodity play, without the ability for companies to use technologies to make new discoveries and mine more efficiently.
In my view, the metals are likely to only keep up with inflation before fees and taxes. And ETFs that own the metals themselves are taxed at higher rates.
Between awful performance over the past several years and Vanguard all but abandoning this strategy, my first instinct is to just not own any precious metals and mining stocks. Luckily, I’ve long since acknowledged that my instincts are usually wrong when it comes to investing. But precious metals and mining are not for the faint-of-heart.
Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected] or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.