Observation of the precious metal sector has demonstrated several factors that should not be ignored by investors and collectors alike. Social media is awash with photographs of stacks of silver bars and silver coinage covering tables and floors, clearly several years of purchasing. Yet these investors are concentrating their risk and are potentially limiting their upside in many potential scenarios.
This article will discuss some of the issues such as when investors see a spike in the spot price and all rush immediately try to sell silver coins at the same time causing a disparity between the paper silver market price and the physical silver market.
Gold and Silver Historical Price Movements
Silver is universally accepted as a store of value and a hedge against currency debasement. It has demonstrated several times, however, that it is not as effective as gold when crisis strikes the global economy. When the coronavirus lockdowns were initially announced, the silver spot price collapsed from $17.31/oz to its low of the move of $12.90/oz, a loss of -25.48% (this being just over a quarter). By comparison, gold was down -14.35% over the same period which shows much more resilience. This is not an exception as when we observe market movements in the onset of the 2008 great financial crisis a similar paradigm is observed.
On 7/8/2008 the silver spot was $16.49/oz on the open, the silver price tumbled and did not bottom until hitting $8.42/oz, a loss of -48.94%. Gold, by comparison, fell from $878.65 to $680.80, a loss of -22.52%. So, we deduce from this data that gold is a much better safe haven than its peer. If the investor is holding precious metals to hedge systemic risk in an equity portfolio, then they will duly do better by buying gold sovereigns rather than silver bars, for example. However, what can the immediate price recovery of the precious metals during these periods tell us about the relationship between gold and silver price action during a global economic crisis?
From the lows mentioned in the preceding paragraph, silver hit a high of $29.84/oz on 7/8/2020 whilst gold hit a high a day earlier of $2072.5/oz. This led to a very impressive upside gain of 131% for silver and a much smaller gain of 42.83% for gold. Whilst one could argue that Silver is not as resilient in a downtrend, they must also acknowledge that the upside is amplified for silver positions relative to gold. Even this though is not as clear-cut as one would hope because small bullion traders in the UK notified the author of this article that the rapid spike in silver prices led to many sellers offering their coins and bars for below the spot price in order to sell it.
When Silver Investors Bottle Neck the Market
The dynamics of the physical market changed with the rapid parabolic rise in silver spot. The buyers were reluctant to buy the top of the market whereas the sellers had been waiting some time for the market to rise and so were all trying to sell at the same time. Competition between sellers forced them to drop their ask way below spot to attract buyers given that there was a lot more sellers than buyers in the market.
This was not evident in the gold market at the time which was able to find equilibrium in the physical market much closer to the spot price of gold. Conventional market wisdom will tell you that silver is a much more volatile precious metal investment than gold and may appear to risk embracing collectors and investors who are looking to maximize their gains on the upside even if they are much more vulnerable to market declines.
Diversification Pays Dividends
The savvy investor could notice this relationship between the two metals and profit from it using the following strategy. Hold a mixture of silver and gold so that there is some facility to maximize profits in a bull market with the silver position whilst also using the gold for its better safe haven properties. When a market has declined, the investor will do better to sell some gold to increase their silver exposure. Then, as the market climbs, unwind some of the silver position to buy back the gold. This kind of move is easier said than done but time and time again we observe how profitable it can be.
Empirical observation has shown that there is no clear winner when determining which metal is best because the performance of gold and silver change in different environments. Whilst not offering financial advice, the author acknowledges the overwhelming evidence to say that a precious metal portfolio that has a mixture of large silver bars, silver coins, gold bullion bars and smaller fractional gold such as British Sovereigns will position the investor well for any macroeconomic development. However, as a rule, the larger the bar of gold that an investor buys the lower the premium above spot price they pay. So, diversifying one’s gold assets is important too.
A hidden advantage that Silver has over Gold is if prices of both metals increase dramatically, the retail market for large gold bars and coins will become smaller because some buyers will be priced out of the market. Fractional Gold may perform well in this situation as its affordability remains in reach for some of the lower capitalized investors. Silver, however, should stay well within reach of the precious metal retail buying community. It could also be argued that trading volume for silver bars and coins could increase in a high-priced environment given that the investors that have been priced out of the gold market may seek sanctuary in silver coinage.
Should I Hold All My Money in Gold and Silver?
Whilst this is a common practice for many investors who subscribe to the belief that gold and silver will always go up over the long run due to currency debasement, it is not advisable to put all of one’s wealth into bullion. There are two reasons for this, diversification of a portfolio can significantly reduce the volatility of your wealth as well as a well-diversified portfolio being easier to predict returns.
The main reason, however, is that whilst precious metals typically appreciate against fiat currency, there will be years in which equities outperform non-yielding bullion. During periods where gold and silver prices are declining or rangebound, equities may be enjoying protracted rallies. For this reason, it makes sense to put some of your wealth into the stock market. Even as seasoned veterans such as Andrew Maguire state in 2022 that silver is the cheapest commodity on earth, the temptation to over-expose oneself to Silver should be cautioned.
Silver and Black Swan Events
As silver is a smaller market in terms of market capitalization than gold, the market is easier to manipulate. This can work like a double-edged sword insofar that prices can be pushed lower during the illiquid Asian trading sessions, but as retail investors demonstrated during the Silver Squeeze, that coordinated buying of physical Silver can push the price higher and force short sellers to liquidate their positions which, in turn, drives prices even higher.
Whilst gold is perceived as a very stable asset, silver is more volatile and is more likely to be subject to these swings in price linked with bullion banks dumping paper silver contracts onto the market in thin trading to push prices lower. The converse holds too, as retail investors can coordinate their buying which, as we observed during the silver squeeze in the summer of 2020, can cause a spike in silver spot prices.
Disadvantages to Silver Investment
As silver is a lower value metal relative to gold, it takes more silver mass to store a few thousand pounds worth of value into silver bullion than it does for gold. Whilst smaller investors get more for their money by purchasing silver, there are two issues that is worth considering due to silver’s low value per ounce. Firstly, it’s a lot harder to store tens of thousands of pounds of silver than it is bars because of the amount of space needed. The second, and most important issue, is that when selling the silver bars online it requires the seller to pay high shipping costs due to the bulky nature of silver. In the UK, the Royal Mail charges £17-£20 to send up to 5kg of silver within the UK, which adds on a significant cost to buy and sell moderate quantities of Silver.
A Silver Lining
Silver’s demand is dependent on industrial activity such as solar panel and glass manufacturing. This means that silver prices can drop somewhat when a recession is expected whereas gold demand is less sensitive to industrial activity. Notwithstanding this, silver is still an asset for equity investors as the author’s own calculations from comparing the closing silver prices in GBP against the FTSE 100 closing prices dated between June 2017 to June 2022 show that the correlation coefficient between the two assets is -0.304.
This means that the silver price and FTSE 100 tend to have a moderate inverse relationship over this five-year period. During sessions where the FTSE falls, silver managed to hold its value and even rally, on average. This makes silver an effective hedge for UK equity investors. Having said this, gold is an even better hedge against losses in UK equities as the same time showed a correlation coefficient of -0.5209 meaning that the relationship between gold and the FTSE 100 is even more negative than Silver making gold a better hedge against losses for investors in UK equities.
A Final Word on gold Diversification
Investors in precious metals may not realize the value of diversifying the type of assets that they hold when first starting out. The gold and silver markets will go through various cycles in an investor’s lifetime and depending on the type of gold investments that you have made over the years will determine how well you can profit from short-term swings in precious metal prices.
It is best to hold a mixture of gold bullion bars and coins as well as some numismatic coins. The reason for this is that bullion investments track the gold spot price very closely. A rally in the gold price will put bullion bars and coins in the money. However, if the gold spot price drops after an investor purchases a bar or bullion coin then that position becomes underwater and will result in a loss if sold.
Some rare numismatic gold coins, however, do not track the gold price much at all. If the gold price drops, its value remains because of its scarcity and collectability. A diversified investor can still sell some of their numismatic coins if the gold spot price drops and make a profit. So, the key to diversification is to buy bullion when the spot price has been going down and to buy numismatic when the spot price is high. This allows the investor to limit their risk and is a very sensible strategy for more active traders looking to flip coins and bars for profit.
Observation of previous market trends shows that silver is a much higher volatile metal than gold. It tends to exaggerate the movements in gold, declining farther in downtrends whilst outperforming in bullish conditions. Gold is a more resilient investment and holds its value very well when macro events are causing large losses in other assets such as shares.
It is advisable that one invests in silver and gold rather than just a single metal as the two assets oftentimes move in tandem but have slightly different characteristics. For instance, silver is used in many industrial activities making it more sensitive to the economic cycle. Gold is in higher demand when people are worrying about the macroeconomic outlook, and so the demand for both metals is contrary.
Moreover, precious metals investors should consider investing part of their wealth in equities as shares provide cashflow through dividends, provide diversification, and can outperform both silver and gold during certain economic conditions.