In recent weeks, many investors reluctant to add to their gold positions are asking me if they would be better off getting their exposure to precious metals through silver instead. While I don’t have strong views on the direction of silver prices, I think it’s important to distinguish between silver and gold, rather than assume that the two metals are interchangeable.
To be sure, it’s not unreasonable that gold and silver (along with platinum) are often lumped together in the precious metal basket. Silver, like gold, is viewed as a store of value and indeed has acted as a form of monetary base in the past. (History buffs will recall the late 19th advocacy of “free silver”, a debate memorialized by William Jennings Bryan, in his famous Cross of Gold speech at the 1896 Democratic National Convention).
But while silver shares many characteristics with gold, here are three important differences between the metals.
- Silver tends to be more sensitive to economic variables, while gold is often more sensitive to monetary variables. Industrial uses make up a large portion of silver demand — roughly 40%. In contrast, gold demand is driven almost exclusively by investment and jewelry demand. Thanks to its strong tie to industry, silver tends to be far more sensitive to economic variables, such as industrial production and manufacturing demand, than gold is.
At the same time, gold tends to have a higher correlation with monetary variables such as real interest rates, inflation and changes in the value of the dollar. For example, based on annual data over the past fifty years, gold prices have had a 0.5 correlation with inflation, while the correlation between silver and inflation is around 0.35. And in earlier posts, I’ve written much about the high correlation between gold’s returns and real interest rates. While the same relationship holds for silver, it is less strong.
- Silver and gold come from different production sources, which can have an important bearing on their prices. The majority of silver is produced as a by-product of lead, zinc, copper and gold production. As such, there is not as tight a relationship between silver production and silver prices as there is between gold prices and gold production.
- Silver prices can be more volatile than gold prices, partly owing to silver’s lower ounce value and smaller market size. This volatility can make silver less attractive than gold to some investors from a portfolio construction perspective.
So where does understanding these differences leave investors?
Whether investors should consider exposure to silver or gold, or both, partly depends on why they are allocating to precious metals in the first place. Those investors that view their position in precious metals primarily as an inflation hedge may want to consider gold, which, at least historically, has done a better job of hedging portfolios against rising prices. However, investors that are looking to play a cyclical rebound in the global economy may want to consider silver because silver prices are likely to benefit more from an uptick in manufacturing.