After rising nearly 12% from its June lows, silver has been garnering some attention in recent weeks, as investors and market watchers look for something to get excited about amid the broader market’s low volatility and slow grind higher. It’s no wonder, then, that many are asking whether it’s time to jump on the silver bandwagon.
My take: Despite the precious metal’s recent rally and though silver may be somewhat more interesting than gold, I’m not convinced that this is a market that most investors want to chase.
First, it’s worth putting silver’s recent rise in context. Here are three important facts about the recent rally.
1. While the metal has had a respectable run over the past month, silver is still playing catch-up after losses earlier this year. Between late February and early June, silver prices fell roughly 15%. In addition, even with the recent rally, for the first half of the year silver has trailed gold, which has gained nearly 10% versus roughly 7.5% for silver. Prices are based on spot prices for both gold and silver from Bloomberg.
2. The recent jump in silver prices is partly a function of the metal’s volatility. Silver tends to be a relatively thinly traded market. As a result, price movements – both gains and losses – are more pronounced. Looking at monthly price data over the past forty years, gold prices have had an annualized volatility of roughly 20%. While this is high – about a third higher than that for U.S. equities – it pales in comparison to silver prices, which have an annualized volatility of nearly 35%.
3. Part of the reason that both silver and gold have advanced this year is that interest rates have unexpectedly dropped. Commodities in general, but precious metals in particular, tend to produce higher returns when real rates are lower. Real yields – based on yields of 10-year Treasury Inflation Protected Securities (TIPS) – were 0.76% at the end of 2013 versus approximately 0.25% today.
Looking forward, however, this environment is unlikely to continue. I expect real rates to start to back up in the second half of 2014. This suggests a tougher second half for precious metals, particularly for gold, which has historically had the stronger relationship with real rates.
In addition to the potential headwind from higher real rates, it’s also not clear that either metal is that mispriced. Valuing commodities is notoriously difficult, as there are no cash flows.
Still, on a relative basis, it’s instructive to compare the prices of certain commodities to each other. For example, three years ago, silver traded at close to $50 an ounce. At the time, this was a ratio of 32-to-1 versus gold; meaning gold was trading at 32x the price of silver, a level that suggested that silver was very expensive, at least relative to gold. Since then, the price of silver has fallen by more than half.
Today gold is trading at roughly 63x the cost of silver. While this is slightly above the forty-year average of 58-to-1, it’s well within the margin of error. This suggests that neither metal looks particularly cheap or expensive relative to the other.
For investors looking to take a bet, one factor favoring silver is arguably the economy. Fifty percent of silver demand is tied to industry. If the economy does improve, silver demand should rise faster. That said, both silver and gold are vulnerable to higher real rates, neither looks particularly mispriced, and investors in silver will need to contend with a lot of volatility.
While I believe that most investors should always have a small allocation to precious metals, it’s not clear that this is the time for a dramatic increase in the allocation to either metal. For investors looking to add to positions or for an incremental play on global growth, I’d prefer cyclical stocks or Japanese equities over both silver and gold.
Sources: BlackRock, Bloomberg
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