While gold and silver have each functioned as money throughout the ages — and both assets have come to be utilized by investors as potential valuable diversifiers in an investment portfolio — they may not provide the same level of diversification, performance or risk management. Dig into the details and see how each asset has performed over time through different business cycles.
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.
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.
Figure 1: Precious Metal Demand by Sector
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.
Figure 2: Gold's Cyclical and Counter Cyclical Demand Diversity on Display
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).
Figure 3a: Rarity Bumps Up Gold’s Price and Potentially Insulates Gold’s Price Volatility
Figure 3b: Rarity Bumps Up Gold’s Price and Potentially Insulates Gold’s Price Volatility
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.
Figure 4: Gold-to-Silver Ratio and Understanding the Price Point
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.
Figure 5: Gold’s 1-Year Correlation at a Glance
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.
Figure 6: Measuring the Longer-Term Effects of Diversification Efficiency
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.
Figure 7: Rolling 1-Year Annualized Volatility of Gold and Silver
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.
1Bloomberg Finance L.P., State Street Global Advisors, date as of February 28, 2022. Note: Since 2000, the correlation of gold to stocks, bonds and other commodities was 0.04, 0.33, and 0.40, respectively. Computed using monthly return data from January 1, 2000 to February 28, 2022. Correlation measures the degree to which the deviations of one variable from its mean are related to those of a different variable from its respective mean. Stocks represented by S&P 500 Index; Bonds represented by the Bloomberg US Aggregate Index; Commodities represented by Bloomberg Commodity Index. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
2Assets may be considered “safe havens” based on investor perception that an asset’s value will hold steady or climb even as the value of other investments drops during times of economic stress. Perceived safe haven assets are not guaranteed to maintain value at any time.
3State Street Global Advisors and World Gold Council, data as of December 31, 2021. Note: Gold averages a daily turnover of $131 billion, a volume on par with the S&P 500 Index of $245 billion.
Bloomberg US Aggregate Bond Index TR
A benchmark that provides a measure of the performance of the US dollar-denominated investment-grade bond market, which includes investment-grade government bonds, investment-grade corporate bonds, mortgage pass-through securities, commercial mortgage-backed securities.
Consumer Price Index (CPI)
A widely used measure of inflation at the consumer level that helps to evaluate changes in cost of living.
Bloomberg Composite Gold Inflation Adjusted Spot Price
Prices are calculated by using the spot gold index and the monthly U.S. Urban consumers price index.
Bloomberg Composite Silver Inflation Adjusted Spot Price
Prices are calculated by using the spot silver index and the monthly U.S. Urban consumers price index.
MSCI ACWI Global Index
MSCI’s flagship global equity index, is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 27 emerging markets.
Spot price of gold
Quoted as a US Dollar per Troy Ounce.
Spot price of silver
Quoted as a US Dollar per Troy Ounce.
S&P 500 Index
Widely regarded as the best single gauge of large-cap US equities, it serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
S&P GSCI TR Index
Widely recognized as the leading measure of general commodity prices movements and inflation in the world economy. The index is calculated primarily on a world production weighted basis, comprised of the principal physical commodities futures contracts.
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