Does Silver Shine as Bright as Gold?
When it comes to investing for the sake of portfolio diversification, most investors prefer to add gold to their kitty. Silver is generally ignored. Why is that so? The article highlights the reasons and also points out to newbie investors the pitfalls of parking funds in this metal
Silver, the white precious metal and close cousin of gold, has always got step-motherly treatment when compared to the yellow metal. Most of the investors hold gold as a hedge against economic downturn while silver is generally neglected. But does silver also have the same property as gold and can investors use this to diversify their portfolio? Our study of daily returns of gold and silver in USD terms since the start of 1980 shows that there is correlation of 0.72 between them, which means they move almost in tandem. Therefore, logically speaking, silver can also be used in place of gold as an asset for diversification.
The testimonial to this is the gain in the price of silver last year during the period of economic uncertainty, just like the gain in gold price. Silver reached a seven-year high in the month of August 2020 as concerns about a weak dollar and declining bond prices thrust investors to safe haven assets as vagueness about the economy remained.
The price of silver has not declined much since then and is still trading above USD 25 per ounce, though it has come down a bit from its recent peak of USD 30 per ounce. If we compare the price rise of gold and silver since the start of 2020, silver has gained almost twice as much as gold.
Although the economy is a stronger footing now, the price of silver has remained intact. It is still trading at about USD 25 an ounce, more than a 50 per cent increase compared with last year and about a 70 per cent rise from five years ago. One of the reasons for such a performance is that the white metal has a peculiarity of acting as both base metal as well as precious metal. It has immense industrial use. It is estimated that 56 per cent of the silver is used in industrial production and thus its price behaviour is often linked with the state of an economy. The global economy according to International Monetary Fund is projected to grow at 6.0 per cent in 2021 and 4.9 percent in 2022.
Hence, the price of silver is expected to remain at an elevated level. Moreover, in the recent past, it has acted more like precious metal during the uncertainty related to the global trade war and Brexit and we have already elaborated how it acted during the recent corona virus outbreak. Of late, silver has been steadily moving higher in line with other base metals like copper and traded in a broad range. Some analysts say silver tends to do well in a stock market crash if it is already in a bull market. Otherwise, it could struggle. During 2019 silver was already in the bull market. In the year 2019 silver had gained 20 per cent (from USD 15 per ounce to USD 19 per ounce) and hence in the year 2020 – when the market crashed – silver continued to move up and crossed USD 30 per ounce in October 2020.
Portfolio Diversifier
The prime characteristic of an asset to be part of any portfolio is that it should have very low correlation with other assets of the portfolio. The correlation between the daily return of silver and the Sensex since the start of 1980 is 0.052, which is very low. The good part is that many a times when there is stress in the economy, silver performs. The following graph shows one year rolling correlation between silver and the Sensex daily returns. It indicates that the correlation varies between 0.3 and negative 0.1.
The chart clearly shows that during the dotcom bust and after that the correlation between Sensex and silver return was either very low or negative. Similarly, even during Brexit we saw the correlation falling below zero. Therefore, silver seems to be a good bet to diversify your portfolio. Nonetheless, another important factor that must not be missed before adding any asset to your portfolio is the return generated by it. Although in recent years silver has generated return in excess of gold, the long-term record of silver is not very illustrious. It has generated absolute negative return since 1980. Silver, in the last 41 years, has given a compounded annual growth rate of negative 1.14 per cent. Besides, silver also has large drawdown. In our study period it shows a maximum drawdown of more than 90 per cent.
When compared to its yellow cousin gold, silver does not generate consistent return and many a times it is manipulated. For example, in early February 2021, traders on Reddit’s Wall Street Bets forum sent silver prices spiking to an eight-year high. Back in 1979-80, a pair of billionaire brothers, the Hunts, tried to corner the global silver supply, sending its price from USD 11 per ounce to nearly USD 50 per ounce.
Any Silver Linings?
Silver is a cheaper alternative to gold and also has some intrinsic qualities of its own. It is less costly than gold and its spot price in the financial market has never exceeded USD 50 an ounce. Gold trades in four figures and costs 70 times more than silver. So silver is more affordable and you can buy in greater quantity than gold. But silver also comes with unique considerations and risks that investors need to consider. Silver is more volatile than gold. The annual volatility in the prices of silver is 25.85 per cent compared to 15.78 per cent of gold. In a worst day fall, the price of silver has fallen by as much as 31.65 per cent compared to 17.38 per cent by gold.
Besides, silver is less liquid and has more impact cost when you try to sell it. These factors along with its dependence on different industries make it difficult to predict the price of silver. Therefore, our suggestion to you is that if you are a newbie investor, stay away from silver and if you want to take exposure to commodities, you can stick to gold as a portfolio diversifier. Nonetheless, if you are an experienced investor and have a risk appetite, you can take a limited exposure to the silver.