The Investor's Guidebook to Alternative Investments

1. Alternative investments offer unique advantages in uncertain times

The first step in studying alternative investments is to define them. Unlike equities and debt, which have very specific definitions, reasonable investors disagree over what constitutes an "alternative investment."

Defining alternative investments. Alternative investments encompass a wide range of assets beyond traditional stocks and bonds, including precious metals, gemstones, energy exploration partnerships, real estate, and collectibles. These assets often behave differently from conventional investments, potentially offering:

• Lower correlation with traditional markets
• Hedge against inflation and economic instability
• Unique risk-reward profiles
• Potential for higher returns in certain market conditions

Current economic landscape. The global economic environment has created renewed interest in alternative investments:

• Loss of faith in sovereign governments and major banks
• Concerns about fiat currency stability
• Growing national debts and deficit spending
• Geopolitical tensions and economic uncertainties

2. Gold remains a timeless store of value and hedge against economic instability

Gold is forever. It is beautiful, useful, and never wears out. Small wonder that gold has been prized over all else, in all ages, as a store of value that will survive the travails of life and the ravages of time.

Gold's enduring appeal. For millennia, gold has served as a reliable store of value and medium of exchange. Its unique properties make it an attractive investment:

• Scarcity and limited supply
• Durability and resistance to corrosion
• Universal recognition and acceptance
• No counterparty risk (when held physically)

Modern gold investment options. Investors can gain exposure to gold through various means:

• Physical gold (coins, bars)
• Gold ETFs and mutual funds
• Gold mining stocks
• Gold futures and options

Potential drawbacks. While gold offers many advantages, investors should consider:

• No regular income (dividends or interest)
• Price volatility in the short term
• Storage and security concerns for physical gold
• Potential for government confiscation (historically)

3. Silver, platinum, and palladium present additional precious metal investment opportunities

Silver is usually not "cost effective" to recover so, unlike gold, most of the silver that's consumed eventually ends up in landfills.

Unique characteristics of silver. Silver offers distinct investment attributes compared to gold:

• Lower price point, making it more accessible to small investors
• Industrial applications create additional demand
• Potential for higher price volatility

Platinum and palladium. These precious metals have their own investment merits:

• Rarity (especially platinum)
• Critical industrial applications (e.g., catalytic converters)
• Limited global production sources

Investment considerations. When investing in these metals, consider:

• Higher price volatility compared to gold
• Industrial demand fluctuations affecting prices
• Storage challenges (especially for silver due to its bulk)
• Potential for supply disruptions (geopolitical risks)

4. Gemstones provide both aesthetic value and potential investment returns

The value of a string of pearls is determined by many factors including: The thickness of the nacre—Fine pearls have layer after layer of nacre that took the mollusk years to lay over a small irritant.

Understanding gemstone investments. Gemstones offer a unique combination of beauty and potential appreciation:

• Diamonds: The "4 Cs" (cut, clarity, color, carat weight) determine value
• Colored gems: Rarity, color intensity, and clarity drive prices
• Pearls: Nacre quality, size, and matching affect value

Investment considerations. When investing in gemstones:

• Seek expert guidance for authentication and valuation
• Be aware of treatments that may affect value
• Consider liquidity challenges compared to other investments
• Factor in storage, insurance, and potential wearing of the gems

Market trends. The gemstone market is influenced by:

• Changing consumer preferences (e.g., colored gems gaining popularity)
• New sources of supply (e.g., lab-grown diamonds)
• Economic conditions affecting luxury goods demand

5. Energy exploration partnerships offer high risk-reward potential

The tax benefits of drilling programs are substantial. All of the costs of acquiring, drilling, completing, and managing the well are tax deductible in the year they are incurred and are distributed to the investors on a pro-rata basis.

Structure of energy partnerships. Energy exploration investments typically involve:

• A managing partner with industry expertise
• General partners providing capital
• Acquisition of mineral rights and drilling operations
• Revenue sharing based on energy production

Risk and reward profile. Energy exploration offers:

• Potential for significant returns if successful
• Tax benefits through deductions and credits
• High risk of capital loss if no energy is found
• Exposure to energy price fluctuations

Investment considerations. When evaluating energy partnerships:

• Assess the track record of the managing partner
• Understand the specific geological prospects
• Consider the current and projected energy market
• Evaluate the tax implications for your situation

6. Real estate investments span diverse categories with varying risk profiles

The classic argument for investing in real estate is: "They aren't making any more of the stuff." While there is a constant "supply" of real estate, the population is ever increasing—raising demand.

Types of real estate investments. Real estate offers various investment categories:

• Commercial (office, retail, industrial)
• Residential (apartments, single-family homes)
• Specialty (hotels, healthcare facilities)
• Raw land and development projects

Investment vehicles. Investors can access real estate through:

• Direct ownership
• Real Estate Investment Trusts (REITs)
• Real estate partnerships
• Real estate mutual funds or ETFs

Key considerations. When investing in real estate:

• Location remains a critical factor
• Understand local market dynamics and trends
• Consider property management responsibilities
• Evaluate financing options and leverage
• Be aware of potential illiquidity

7. Portfolio diversification with alternative assets can enhance risk-adjusted returns

One of the benefits of alternative investments is that they have a low correlation with traditional stocks and bonds and therefore improve the return/risk portfolios when they are added to traditional portfolios.

Principles of diversification. Adding alternative investments to a portfolio can:

• Reduce overall portfolio volatility
• Potentially enhance long-term returns
• Provide hedges against specific economic scenarios

Correlation benefits. Alternative assets often have low or negative correlations with traditional investments:

• Gold may rise when stocks fall during economic crises
• Real estate can provide steady income and appreciation
• Commodities may outperform during inflationary periods

Portfolio construction. When incorporating alternative investments:

• Determine appropriate allocation based on risk tolerance
• Regularly rebalance to maintain desired asset mix
• Consider liquidity needs and investment horizon
• Evaluate total portfolio costs and tax implications

Last updated: July 28, 2024