Do you really need gold plus silver funds? 

With the stock markets stuck in limbo and bonds turning volatile, AMCs have been latching on to the only performing asset – precious metals – for new products. After gold ETFs/funds and silver ETFs/funds, the latest fad is gold-and-silver funds which invest in both gold and silver in a single portfolio. 

Funds from Edelweiss and Motilal Oswal 50:50 allocation to gold and silver ETFs. The newest Gold-Silver fund from Mirae promises to dynamically juggle allocations between the two metals. 

A Gold-Silver combo may look like a match made in heaven today, because their returns are almost identical (at 52 and 50 per cent respectively for the last one year). So is this combination worth adding to your portfolio?

To put it bluntly – no. Here’s why.

To pitch this product, AMCs are showcasing returns of 50:50 gold-silver portfolios over trailing 1, 3 and 5-year periods. But longer history shows that gold and silver seldom perform in tandem. Blockbuster returns from two different assets that happen to come at the same time does not mean that you should combine them into a single fund. 

Second, an analysis of the long-term performance of gold and silver shows that these two metals serve very different purposes in the portfolio, and therefore any allocation you make needs to be looked at individually. Gold is a good hedge because it delivers returns when there’s a global recession, turbulence, or geopolitical tensions. Silver is an industrial commodity that outperforms in booms and economic recoveries. 

Here’s a more detailed look at why you can safely avoid these combination gold-plus-silver funds and why you should take the two exposures separately.

Different use cases

Let’s start with what drives returns. Gold and silver are very different animals because their sources of demand are very different. 

Over 50% of the annual demand for gold comes from central banks, ETFs, OTC markets and bar and coin purchases. All these buyers are essentially looking at gold as an investment. Central banks buy gold as a diversification bid from fiat currencies, especially the US dollar. Bar, coin and ETF buyers look to buy gold as a store of value or for its returns. As both these sets of buyers rush into gold when global economies or financial markets are turbulent, gold acts as a good safe haven. An earlier report we wrote on gold explains the key drivers behind gold prices. 

In contrast, silver dons the hat of an industrial commodity more than investment. Though silver has found new use-cases in electronics and electric vehicles, silver is essentially demanded as an industrial raw material. Just 16% of its purchases originate from investors. You can find long-term demand supply projections for silver here. So while silver may be a precious metal, its prices are driven by industrial factors like other commodities and not as a hedge or investment.

This is an important distinction. Investors behave very differently from industrial users in responding to price rises. 

• Investors are quite happy to rush into an asset when prices rise because they like to chase past returns. Industrial users on the other hand cut back purchases when prices rise, as this will hit their margins. Spells of high returns on gold therefore tend to last longer than those on silver. 
• Silver doesn’t have the safe-haven qualities of gold because when a global slowdown hits, industrial demand falls thus reducing silver offtake. The recent rally in silver has been fuelled by expectations of a persisting demand-supply deficit over the next 3 to 4 years. But if silver prices spike a lot, projected demand may well moderate. 

Behaviour in market falls 

The above user profile is the reason why gold has been the better asset to own during stock market crashes. Looking back at how gold and silver behaved for Indian investors, in significant market crashes over the last 20 years, this is the picture that comes to light.

In every 20% plus stock market fall, gold has delivered good gains for Indian investors. Silver however has lost value in three out of four occasions. This underlines that while gold makes for a good portfolio hedge, you cannot rely on silver to shield your portfolio when stock markets tumble. 

Combining gold and silver in a single portfolio can result in silver offsetting part of the gains from gold during times of crisis. 

Differing risk-return profile 

It is only recent returns that have been similar for gold and silver. Historically, these returns have not moved hand in hand. Nor are their risk-return characteristics similar. 

A 20-year rolling return analysis of gold and silver returns (based on Indian prices in Rupees) shows that:

• Gold has been the more reliable performer, with average returns of 10.4% over 1-year periods and median returns of 12.3%. Gold has also contained downsides well with a 15.6% drop in its worst year. 
• Silver, on the other hand, is quite an erratic asset. Its median returns of 4.4% are far away from its arithmetic mean of 11.9%. It delivered 150% gains in its best year but also dropped 29% in its worst year. 
• The data on the number of times gold and silver have delivered poor returns (less than 6% and negative returns) is also eye-opening. Silver has delivered losses about 40% of the times for 1-year periods and 27% for 5-year periods compared to much better metrics for gold. 

Therefore, hanging on to silver as a permanent exposure in your portfolio will drag down returns. 

This argues for having gold as a permanent exposure in your portfolio, as a counter-weight to equities. If stocks crash, gold may gain smoothening out your portfolio returns. Silver is a tactical investment to boost your returns when the global demand outlook is strong. Periods of high returns on silver also don’t last long. Therefore, tactical entry and exit are critical to retaining your returns from silver.

Timing it

If steady-state allocations to gold and silver don’t work, will dynamic allocations work? Well, this depends on how successful a fund house is in timing its calls. Given that gold delivers its best show when Black Swan events hit, it is close to impossible to predict when gold will perform (Black Swan events by their very definition being unpredictable). Therefore, it makes sense to hold gold as a constant allocation in your portfolio, with the exposure depending on your equity weights. 

Tactical entry and exit can help you use silver as a return kicker to your portfolio. However, given that silver (and gold too) offer no cash flows and therefore have no formal valuation metrics, entry and exit calls on silver can only be based on technical analysis, or analyzing industrial demand-supply as with other commodities, or other informal metrics. 

A common metric used by traders and analysts to gauge valuations for silver versus gold is the Gold:Silver ratio. This is the ratio of international silver prices to gold, expressed in US dollars. It calculates how many ounces of silver are required to buy gold at any given point in time. 

However, a study of the Gold:Silver ratio over the last 20 years suggests that it is a very imprecise indicator. In the last five years or so, buying into silver when the Gold:Silver ratio was at 90 times or above has led to good gains on silver in the next one year. 

However, this threshold of 90 is only evident with the benefit of hindsight. The entry point used to be much lower at 60 a decade ago. The Gold:Silver ratio has averaged 69 in the last 35 years but has swung between a high of 111 and a low of 34. 

In fact, a steady climb in the Gold:Silver ratio over time goes to show that gold has consistently outperformed silver – which has delivered returns in fits and starts. This again makes a case for tactical allocations to silver and avoiding funds that combine the two precious metals. This earlier report we published does the number-crunching to tell you how you should approach gold allocations in your portfolio to reap its safe haven benefits. 

Therefore, don’t be enamoured with current high silver returns or funds that seem exciting in their presentations.