Portfolio Diversification via Gold or Silver?

While both gold and silver are precious metals, the demand-supply forces and the economic sensitivities of both metals are quite different. It is good to understand the difference between the two precious metals as portfolio diversifiers.

Gold is God's money. It has virtually no perfect correlation with any other asset class. Many times, it does show reverse correlation with equity asset class, but that cannot be said as a rule.

Gold prices are dependent more on the supply-demand equation and geopolitical factors impacting it, which is why they tend to stay dormant for extended periods of time, followed by a sudden and volatile spurt. It is difficult to value gold like other assets based on cashflows and intrinsic value.

Silver May Be More Tied to the Global Economy

On the other hand, silver isn’t just a precious metal. It’s also a base metal with industrial use. Silver prices tend to be more volatile than gold. In times of economic and geopolitical uncertainties, silver (along with gold) acts as a hedge and behaves like a heaven that precious metals are expected to. But at other times, it is more like a base metal with industrial demands. To some extent, this means that investments in silver are linked to global economic growth.

To understand the impact the correlation of silver with economy, we must understand its industrial usage. Half of all silver thats available or produced every year is used in heavy industry and high technology, including smartphones, tablets, automobile electrical systems, solar-panel cells and many other products and applications, according to the World Silver Survey. 

As a result, silver is more sensitive to economic changes than gold, which has limited uses beyond jewelry and investment purposes. When economies take off, demand tends to grow for silver, and when economies falter, silver does get negatively impacted.

Gold has been a more powerful diversifier than silver.

Silver Is More Volatile than Gold.

The volatility in silver prices can be two to three times greater than that of gold on a given day, primarily because of its strong coupling with the economic activities. While short term traders may benefit, such volatility can be challenging when managing portfolio risk.

Correlation between Gold & Silver

Gold and silver prices have a high correlation. The prices of both move in similar directions for majority of the times. But their dynamics (as explained above) are different. Gold is better insulated during economic slowdowns and silver isn’t (due to its uses in industries). Gold has often shown a sharper negative correlation with economic growth while silver has a positive but moderately weak correlation to the same.

Almost always, it has been observed historically, that gold triggers the initial direction of the bullion space followed by silver but with wilder moves on either side. 

Portfolio Allocation of Precious Metals

Unless it’s a small portfolio or you just don’t want to get into anything other than equity and debt, precious metals can, and should be part of any long-term portfolio.

But it is also important to keep in mind that these precious metals are and should always be treated as portfolio diversifiers and not core components (like equity and debt). So having a 5-10 percent allocation to precious metals can be considered, depending on your investing strategy.

Between gold and silver, I suggest giving disproportionately high weightage to gold. So, let’s say you want a 10 percent allocation to precious metals, then 7-10 percent to gold and a smaller 0-3 percent to silver can be considered. Now, this is not a rule for everyone. This is just a high-level recommendation. Almost everything depends on the investing strategy that your financial advisor has created for you. In fact, silver isn’t required for most people’s portfolios.

Gold and Silver Combo

Indian asset management companies (AMCs) are at the forefront when it comes to launching innovative products. Recently Edelweiss Mutual Fund launched a new scheme that combines gold and silver in a single product.

While individual gold and silver ETFs have been available in India, this new offering -- Edelweiss Gold and Silver ETF Fund of Fund -- mixes gold and silver ETFs in equal allocation (and maintains it via periodic rebalancing) in a first-of-its-kind product in India.

But new offering usually does not mean that we must have it in our portfolio.

How You Can Invest in Gold and Silver

One of the attractions of gold and silver is that both can be purchased in a variety of investment forms:

Physical Metals: Unlike stocks and bonds, gold and silver can be purchased as physical assets, as either bar or coins. Holding bars and coins can have downside, though. For one, investors often pay a premium over the metal spot price on gold and silver coins because of manufacturing and distribution markups. Storage and even insurance costs should also be considered. 

Exchange-Traded Funds: ETFs have become a popular way for investors to gain exposure to gold and silver, without having the responsibility of storing a physical asset. You can buy shares and keep them in a traditional brokerage account. The fund’s operator is responsible for handling the costs of holding a physical supply of gold or silver and charging an expense ratio.

Mining Stocks and Funds: Some investors see opportunity in owning shares of companies that mine for gold and silver, or mutual funds that hold portfolios of these miners.

Summary

Gold is a good enough and much stronger diversifier than silver, when it comes to precious metal allocation. Except in rare cases, silver may not be needed in your portfolio. There is no need to get swayed with everything that is available in the market.

Regards

Manoj Arora
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