Gold versus Silver: Comparing Two Precious Metals

Of all the precious metals, gold and silver have clearly exhibited the best track records as money, with global currencies tied to bimetallic standards for several centuries. US currency linkages to silver lasted until the 1960s, while the US dollar’s tie to gold was abandoned in 1971, when President Nixon ended the greenback’s convertibility to gold at a fixed rate. We often refer to this unpegging of the gold price as “the initial public offering of gold” that democratized gold as an asset and paved the way for gold’s strategic investment role in a modern-day portfolio to help navigate evolving business cycles.

From Currency to Asset Class: Understanding the Two Metals’ Price Drivers
Gold and silver have taken some very different turns since their humble beginnings as currencies, but both now hold appeal for global investors as a potential store of value and source of portfolio diversification.¹ That said, there are some meaningful distinctions in terms of the unique role that each asset can play in a portfolio on a price, performance, volatility and risk management basis.

As with most real assets, the price movement of both assets is driven by their unique sources of supply and demand. Today, silver remains a widely utilized precious metal, with its price largely determined by industrial demand and mining production. Over time, the demand for silver has tended to rise and fall in a linear fashion with the overall growth of the economy, largely due to its diverse industrial applications (see Figure 1).

In contrast, gold maintains a more diverse set of demand drivers, ranging from industrial and technological uses, to a deep global jewelry market. In addition to its use among investors, gold also serves as a reserve asset for central banks around the globe. This diversity of demand, both cyclical and counter-cyclical, has helped to support gold’s low correlation to traditional stocks, bonds and several real assets across various phases of a full economic cycle.

In fact, gold’s unique demand dynamics make it suitable when seeking to manage a range of systemic risks and market challenges during a variety of business cycles. In 2020, gold’s diverse demand benefits were highlighted as global investors flocked to gold at a record pace with its perceived “safe haven”² appeal and deep liquidity,³ a demand shift where the rise of gold investment helped to offset pandemic-related declines in jewelry and central banks.

In terms of supply dynamics, gold’s greater scarcity over silver is reflected in the historical price difference between the two metals. But dissecting that difference reflects how gold’s unique supply and demand characteristics have produced a lower overall price volatility over time and through various business cycles. As illustrated in the first chart, on a tonnage basis, the annual supply of silver is approximately seven times larger than gold. However, on a market value basis, annual silver supply is a fraction of gold, potentially leading to less liquidity and higher volatility in the global silver market (see bottom chart).

Where Performance Meets Portfolio

The gold-to-silver ratio is a technical pricing indicator that can be used to evaluate the relative value of each precious metal. As shown below, lower ratios reflect gold as undervalued and higher ratios imply silver is relatively more attractive. While the ratio often shows which metal might be currently overvalued, it also illustrates that silver’s reliance on industrial applications to support demand make it more vulnerable to erosion of real returns during certain business cycles, supporting gold’s potential to maintain higher real returns over time.

Dissecting the Diversification Efficiency of Each Asset

Beyond performance, understanding the diversification properties of each asset — or the strength and direction of the linear relationship between assets — is another tool that investors use to pursue an improved risk/return profile. Adding assets that have a low correlation to each other also can provide diversification that helps investors seeking to optimize portfolio performance through cyclical and countercyclical market changes.

As illustrated below, gold’s lower correlation over the past year to both global stocks and broad commodities, highlights gold’s potential to provide higher diversification efficiency on a relative basis compared to the broad movements of these asset classes.

Effective portfolio diversification can be measured by a portfolio’s risk-adjusted returns over time. As highlighted below, gold has historically delivered competitive returns, and on average has outperformed silver during a number of past black swan events. Gold’s track record of hedging against significant equity downturns, thereby reducing portfolio drawdowns, is a key example of one of its potential portfolio diversification benefits.

Understanding the Value at Risk

Volatility is another measure that investors use to understand the level of risk associated with investments in their portfolio. Generally speaking, more volatile assets are deemed to be riskier, providing a greater dispersion of returns and a lower conviction on anticipated performance. Historically, silver is more volatile because of its relatively smaller market size and demand that is levered to manufacturing and industrial production. As shown below, gold and silver rolling 1-year standard deviation of weekly returns highlights silver’s higher volatility relative to gold.

Getting the Most Out of Your Metal

As the 2021 landscape unfolds, several factors may continue to offer tailwinds for gold, silver and other commodities. In fact, diversifiers will likely play an increasingly important role in 2021 helping investors navigate portfolios through rising technical risks and changing business cycles. Understanding how each asset can potentially help optimize risk-adjusted performance is a vital implementation consideration. For investors looking to navigate their portfolios through 2021’s market risks, gold may provide an efficient and less volatile source of ongoing diversification to navigate changing business cycles.