After a long wait, Indian AMCs have recently gotten around to launching Silver Exchange Traded Funds (ETFs). ICICI Prudential, Nippon India and Aditya Birla Sun Life have been first off the block, launching both Silver ETFs and Fund-of-Funds.
These Silver ETFs intend to invest at least 95% of their assets in silver of 99.9% purity. They will benchmark themselves to the daily silver ‘fixing’ – a benchmark price published by the London Bullion Market Association, translated into Rupees.
So, should Indian investors add Silver ETFs to their portfolio? To decide, you should know the kind of returns you can expect from silver, the likely losses in bad years and the key drivers of silver’s performance. Here goes.
To gauge the likely returns from any asset over varying market conditions, rolling returns (which compare returns over multiple time periods) are more useful than trailing returns which are over-influenced by the start and end dates. We used RBI data on monthly average prices to run a rolling return analysis of silver for Indian investors compared to gold for the period from April 1990 to December 2021. We found that gold scores over silver, both in terms of getting you to a double digit return more often and containing losses better.
Here are the findings of the rolling returns analysis:
- Average returns - misleading: The average rolling CAGR on silver has been 8-9 per cent over a 3, 5 and 10-year holding period. While this suggests that silver delivers very respectable returns, the other data refutes this. The ‘averages’ for silver are quite misleading because returns on the metal tend to swing between extremes. In its best one-year period in the last three decades, silver gained 132.6%, but in its worst year it also lost 30.8%. In its best 5-year period, silver managed a whopping 30% CAGR but in its worst 5-year spell it lost 9.9% CAGR.
- Loss probability – higher: The probability of losses shows that silver lost money for investors a good 40% of the time if held for 1 year, 31% of the time if held for 3 years and 23% of the time if held for 5 years. It is only when you held silver for 10 years that the probability of losses fell to 2%. In effect, if silver is an allocation in your portfolio, you should be prepared for losses a good amount of the time.
- Double-digit returns – fewer instances: Though silver gave blockbuster returns in its good years, the good years were not too frequent. Your chances of getting a double digit return with silver were at less than 40% whether you held it for 1, 3 or 5 years and 46% for 10 years.
- Silver vs gold – gold scores: A comparison with gold shows that the yellow metal has a much better record on all the above counts. The average rolling returns on gold over various holding periods (1, 3,5 and 10) are at 8-10% - not very different from silver. But while gold in its best year has never doubled your money, it has not subjected you to terrible losses. The worst loss that gold registered over a year was 20.5%, and losses are lower than silver with longer holding periods. While gold lost you money 25% of the time if you held it for just a year, you could have cut the risk of losses to less than 20% by stretching that holding period to 3 and 5 years.
- Gold also got you a 10% return far more often than silver. In fact, held for 10 years gold got you to double digits 57% of the time against 46% for silver.
Silver as a hedge
Unlike equities or bonds which are designed to deliver you regular cash flows in the form of dividends (earnings) or interest, owning metals such as gold or silver gives you no regular paybacks. Your only hope of return is when their price appreciates. In our past analyses we’ve recommended a 5-10% allocation to gold in your portfolio because it makes for a good portfolio hedge against a correcting equity market. That is, when stocks fall gold usually outperforms, smoothing out your overall portfolio returns.
Does silver do this too? Data shows that gold does a better job of being a portfolio hedge than silver. Some of the worst years for the Indian stock market in recent memory were 2008 (Nifty 50 down 51%), 2011 (Nifty 50 down 23.8%) and 2015 (Nifty 50 down 3%). In each of these years, gold earned positive returns for Indian investors. But silver ended up making losses in 2008 and 2015, gaining only in 2011.
While silver does play the role of a partial hedge for Indian investors because it gains from the Rupee depreciating against the US dollar, silver tends to be adversely affected by global recessions and depressions because it is partly an industrial metal.
Running a long term correlation of global silver prices with copper, zinc and nickel shows that its monthly returns carry a correlation of about 0.31-0.32 with these industrial metals, while silver carries a higher 0.67 correlation with gold. Effectively, silver behaves like a precious metal (or a safe haven) about two-thirds of the time but also behaves like an industrial metal about a third of the time.
This explains why periods of good returns for silver have usually coincided with periods of strong economic growth for the global economy. History suggests that spells of double-digit returns for silver have usually come about when the global economy is reviving strongly from a slump or has sustained 4% plus growth for 3-4 years at a time (such as in 2003 to 2006 or 2009-2012). If you believe that global growth is set to take off for an extended spell from 2022 owing to recovery from Covid, you may like to bet on silver. But current IMF projections suggest slower growth (4.9%) in 2022 from 5.9% in 2021.
A more useful metal
The above analyses tell us that silver has an inferior return profile to gold and is less effective as a hedge against falling stock markets.
Having said this, the one reason for you to prefer silver over gold would be that it is overall, a more useful precious metal with many emerging industrial applications. It has high electricity conductivity and is used in printed circuit boards and electronic components. It is an industrial catalyst. It is used in welding, electroplating, diagnostics and photography and for anti-bacterial properties. It can also be doubled up as a clean and green energy play, as it is used in water purification, PV cells used in solar generation and induction chargers for smartphones and electric vehicles apart from switch contacts and relays used in 5G networks.
Gold in contrast has far fewer real-life applications and sits mainly in vaults. Here’s a break-up of the industrial versus other uses of silver versus gold.
The higher industrial use is why silver often delivers its best show when global economies and industrial activity is booming. But as a commodity whose price should respond to gaps between demand and supply, silver does have some peculiarities.
73% of global silver is produced, not by miners deliberating digging out the metal, but as a by-product of mining other metals such as copper, zinc, lead and gold. Direct silver mining chips in with just 27% of the annual production. This effectively means that silver mining output, unlike the output of gold and most other commodities, may not immediately respond to higher demand or prices. Recycling of old silver contributes a fairly high chunk or nearly 19% of global supplies and this kind of supply can rise sharply if silver prices shoot up.
But one threat that silver doesn’t face like its cousin gold, is a constant threat from central bank selling. Globally, central banks are the largest hoarders of gold and countries in distress often offload chunks of their gold reserves, weighing on its market price.
Bottomline on silver ETFs
Overall, all this points to just two reasons to allocate to silver ETFs.
One, if you believe that global investors will lose faith in gold because its value relies more on perception than actual usefulness, you may prefer to own silver instead through silver ETFs.
Two and more practically, if you believe in leaving a legacy of silverware for your children or stashing away your own wealth in physical silverware in a bank locker, Silver ETFs make a lot of sense as a substitute. They won’t clog up locker/vault space like physical silver. You can own a lot of silver by value without safety worries. Silver ETFs also allow you to cash out of the asset whenever you want to at prevailing market prices, without having to worry about the jeweller short changing you by levying hefty wastage or charges when you trade in your physical silver.