Buying a base metals ETF, like one holding copper companies, is a great way to diversify your resources holdings beyond gold

We think that most investors should have some Resources & Commodities exposure as part of a well-balanced portfolio—10% to 20% is a good proportion for most investors. But rather than focusing solely on gold stocks, we think you are better off getting some of that exposure through oil and base-metal producers as well.

Here’s a look at how to invest in a top base metals ETF:

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Watch for these factors when investing in a base metals ETF

Some of the best metal mining stocks come from companies that have been producing for years. For the mining component of the resources segment of your portfolio, the focus should be on firms with positive cash flow and high-quality reserves. Resource stocks overall (and this includes metals, of course) should make up only a reasonable portion of a Successful Investor portfolio.

“Majors” are typically mining companies that have been in the mining business for many years, and more often than not they operate producing mines on a global scale. Successful majors have proven methods for exploration and mining, and have consistent output and cash flow, year over year. On the other hand, “juniors” typically have negative cash flow since they’re spending money in hopes of finding a mineable deposit.

When we recommend top metal stocks, we want to see positive cash flow, preferably even when commodity prices are low. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient to cover, or at least contribute to, the cost of developing a second mine.

Top base metals ETFs can include those holding copper stocks

The many industrial uses of the “red metal” can give copper stocks an advantage over gold and other precious metal stocks.

Traditionally, investors have bought copper stocks as a way to profit from general economic growth. Copper has a wide range of industrial uses (unlike gold and silver, which are thought of more as hedges against inflation). For instance, copper is heavily used in the construction industry, in cables, wires and plumbing.

Stocks of firms that produce base metals, including copper, generally have higher dividend yields than gold stocks. As well, they’re usually much cheaper than gold stocks in relation to their earnings and cash flow. That means they potentially have less room to fall if markets fall. That’s just another way of saying they can be considered somewhat less risky than gold and other precious metals.

Copper should benefit not just from rising demand, but also from tightening supply. In the short term, labour problems and technical delays will continue to slow global copper production.

Over the longer term, ore grades are also falling at many major mines around the world as producers use up the easy-to-mine ore zones in their copper deposits. Environmental issues are also making it harder for companies to acquire permits for new mines.

To sum up, we like copper’s long-term prospects. But as always, stay out of promotional penny mines that are merely drilling for copper. Also stay out of investment vehicles (like options or futures) that will only make money for you if copper keeps going up in the short term.

Bonus tip #1: Learn why the best base metals ETF to buy will likely be a “traditional” ETF, and not a “new” ETF

We think you should stick with “traditional” ETFs. Traditional ETFs practice “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher costs. Many “new” ETFs also look to add in some active management. Traditional ETFs stick with passive management—they follow the lead of the sponsor of the index.

Sponsors of stock indexes do from time to time change the stocks that make up the index, but generally only when the market weighting of stocks changes. They don’t attempt to pick and choose which stocks they think have the best prospects.

This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investment down.

All in all, we think simple is better.

The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”

Many “new” ETFs focus on narrower indexes and higher-risk strategies, instead of giving you a low-cost way to copy the results of a standard market index.

 Do you think investing in precious metals makes more sense than investing in base metals?