3 reasons silver should be in your portfolio

Demand for silver skyrocketed this week, off the back of the latest campaign from Reddit’s r/wallstreetbets group. Investors may wonder what’s beyond the frenzy and whether the Reddit campaign has unexpected substance to it.

The Reddit story

Following a bid to counter short-selling of GameStop, r/wallstreetbets turned its collective eyes to silver. With the claim from some segments within the Reddit group that silver prices were being held artificially low by bank and hedge fund manipulation and short-selling, amateur investors piled in to purchase silver ETFs and mining companies in a bid to push prices up.

There were record volumes for trades into US silver ETFs on Monday 2 February 2021 and prices rose to eight-year highs.

Source: Bloomberg, 1.2.2000-2.2.2021.

While the GameStop campaign may have been successful in pushing prices up, silver is a different story for a few reasons.

Firstly, silver is a far larger, more complicated and more valuable market compared to the much smaller share pool of GameStop. Silver is used and purchased for industrial and investment purposes and only a portion of the world’s silver reserves is traded on stock exchanges. Effectively, there are more factors influencing the prices of silver than simply share trading.

Secondly, there are only limited short positions in silver, in fact, most banks and investment managers hold long positions on silver and held a positive outlook on silver’s prospects prior to the Reddit rally (1). By contrast, there were concerns over GameStop’s future before Reddit warriors pushed prices up to levels that are now considered vastly inflated compared to the company’s financial position and prospects.

While the rationale for the silver Reddit rally may be flawed (and there are questions over the extent Reddit really caused the rally), investors may have inadvertently selected an asset with a promising outlook and potential benefits to a portfolio. It is up to investors to take the time to assess the value of silver before selling up when the frenzy eases.

The drivers of silver and its outlook in 2021

Silver has a range of uses and more than 50% of demand is for industrial purposes, such as in cars, solar panels, medical equipment and electrical circuits (2). In fact, over 36 million ounces of silver annually are used in motor vehicle production (3) and this is predicted to grow to nearly 90 million ounces by 2025 (4). Silver is also antimicrobial, which makes it popular in medical use (5).

Source: SILVER SUPPLY & DEMAND - The Silver Institute

In 2020, silver supply and demand was affected by COVID-19 with lockdowns dampening industrial demand, while mining production also fell and impacted supply. Industrial production is tipped to ramp up in 2021, supported by government stimulus packages globally, the rollout of vaccines and the prospect of economic recovery. In turn, demand for silver is likely to increase in line with this.

Further, silver is heavily used in renewable energy systems, such as solar panels and as part of electronics. Silver is also likely to benefit from the refocused efforts on climate change globally, with a number of major renewable energy projects announced, such as the NSW government’s $32 billion renewable energy plan (6).

Investment demand for silver was also trending upwards from late 2020, with investors looking for alternative safe-havens to gold. Silver-backed exchange-traded products (ETPs) surpassed 1billion ounces for the first time (7). Silver can be used as a store of value and traditionally offers positive performance during periods of low-interest rates. With the prospect of continued low global interest rate and concerns over potential inflation, investors have shown increased interest in exposure to this precious metal.

The relationship between gold and silver

Investors often view gold and silver as being closely linked. While they have some similar properties in terms of acting as stores of value and offering diversification in a portfolio but there are also some differences.

The gold/silver ratio is often used to determine the value of silver in relation to gold. It measures the quantity of silver required to purchase one ounce of gold. Some traders view it as a way of determining whether either metal is over-or under-valued based on periods where the ratio is particularly small or particularly large.

For example, the chart below demonstrates the ratio increased substantially in 2020 when gold prices surged compared to silver. At this point, some investors may have viewed silver as being undervalued compared to gold. In recent years and even during the Reddit rally, the ratio has averaged around 60. Given the use of silver for industrial purposes has grown substantially across the past decade compared to gold which remains more investment-driven, the ratio may not be as meaningful as in the past and should not be the sole driver of deciding whether or not to invest.

Source: Bloomberg covering the periods: February 2000-2 February 2021

Silver tends to outperform gold more often in bull markets and vice versa in bear markets. This reflects its position as more of an industrial commodity compared to gold with closer links to business cycles.

This is demonstrated in the chart below.

Source: Bloomberg covering the period: 27.2.2009-29.1.2021.

The prospect of economic recovery, and in turn, bull markets, may also indicate the potential for positive performance for silver in the coming year.

Silver in a portfolio

While the outlook for silver has been considered promising, silver can offer a range of benefits to an investment portfolio.

1. Diversification

Silver typically has a low correlation to many other asset classes, meaning it can enhance a portfolio’s overall risk/return characteristics through alternative performance. This is shown in the table below.

Source: Bloomberg, as at 2 February 2021. Correlations are calculated monthly over 20 years in Australian dollars. Australian equity is represented by the S&P/ASX200 Total Return Index. Global equity is represented by the MSCI World Total Return Index. Australian fixed income is represented by the Bloomberg AusBond Composite 0+ Yr Index. Global fixed income is represented by the Bloomberg Global Aggregate Total Return Index.

2. Store of value and hedge against inflation

Silver has been historically used as a store of value. In periods of inflation or deflation where the value of currencies can fluctuate, investors often use physical assets like gold or silver as a hedging tool to support their portfolios.

3. Growth exposure to industrial demand in areas like battery storage and medical devices

In addition to this, investors may consider investing in silver a means of exposure to the growing renewable energy space given silver’s use in batteries and solar panels.

How to invest in silver

The traditional forms of access to silver were either through physical holdings or indirect exposure by owning shares in mining companies. These days, investors can also consider silver-backed exchange-traded products such as ETFS Physical Silver (ASX:ETPMAG).

In a silver-backed ETF, physical silver is stored by a fund manager as part of a trust and investors buy units in the trust for exposure to the market movements of silver.

Using an ETF for silver exposure has several features and advantages over the physical holdings, such as accessibility, ease of use and may be more cost-effective compared to freight, storage and insurance for physical holdings.

Does silver make sense?

Outside of the Reddit rally, which already appears to be fading, silver has a promising outlook for 2021 along with offering a range of beneficial characteristics to an investment portfolio. Offering diversification, a store of value and a growth exposure to industrial demand, silver may be a valuable inclusion for many investors and is worth evaluating as a long-term strategic holding.