[Newsphopick=Kingsley Lim] While gold has always been the metal of choice during a recession, few investors would consider silver as a hedge in falling markets. For reasons which are beyond me, silver has always taken second place to gold as a hedging instrument for falling equity markets. However, silver is also considered a precious metal in the markets. During a recession and panic-driven sell downs in the equity markets, silver’s price does rise in proportion to the ‘fear’.
But because of silver’s status as a secondary precious metal, its performance has not matched that of gold over the last few decades. In 1916, silver’s price was US $16 an ounce. By contrast, its price is just US$25 an ounce, not very far from the prices in the early part of the twentieth century. On the other hand, the rise of gold is quite obvious – in 1916, its price was US $450 an ounce but today, because of the ‘fear’ of a market correction, its price has gone up to US $1,900 an ounce. When one contrasts the performance of the two precious metals, it is evident that gold’s performance has beaten silver’s performance over the last hundred years or so.
The silver is not to be dismissed entirely. For one, the price of silver is relatively cheaper than that of gold. Silver costs US$25 an ounce but gold costs US$1900 an ounce. In times of war and upheaval in the financial markets, physical silver can be broken into small coins which can be used as currency to buy essential items and more. Just one week after the bankruptcy of Lehman Brothers in the Great Financial Crisis in 2008, gold and silver prices went up by 15%.
But three years later, when the European government debt crisis struck, gold increased by 250% while silver quadrupled in value. This feat, is one of the instances where silver outperformed gold.
Overvalued markets call for some allocation of silver and gold in the portfolio
Since COVID-19 hit the global economy, many parts of the world are now beginning to see the economic effects of the coronavirus pandemic. While the second quarter showed a contraction for most countries, the third quarter is likely to show some growth according to economists around the world.
Economists have credited the recovery to the trillions in federal aid that stimulated demand in the US economy. These include stimulus checks, forgivable loans and generous unemployment benefits. These measures and more have helped businesses to survive and to retain a core base of employees during a tough economic environment.
To some, this is puzzling as the number of bankruptcies have just begun to increase. Many popular retailers such as Muji and Neiman Marcus have filed for bankruptcy protection as the demand for its goods have reportedly decreased by 80 per cent or more. Hence, the road to recovery may not be an overnight matter. It will take time.
According to other market observers, the market’s recovery is not real, as speculators and federal aid have created an inflating bubble which may burst. While many parts of the world are in a technical recession now, US markets have been surprisingly resilient, recovering from its April lows to reach news highs again. These chain of events show the irrationality in today’s markets.
At the same time, market valuations have been over stretched. While corporate earnings have fallen by as much as 80 per cent for some companies, S&P 500 and Nasdaq have price-to-earnings ratios of more than 20. If one averages out the earnings of the last ten years, market valuations on that basis, remain stubbornly high at around 30 times for the S&P 500 and 46 times for the Nasdaq. The only other time when it was more expensive was during the dotcom bubble which occurred almost two decades ago.
With markets as high and as irrational as it now is, market observers say that there is a case for a higher allocation of gold and silver in the portfolio. One could think of it as portfolio insurance, protecting the value of one’s assets.
For some, silver is a better instrument for hedging because the precious metal is trading closer to its historical median price. From June 2019 to the present, the price of silver has risen from US$14 an ounce to US $25 an ounce. This is an increase of 78.5 per cent in more than a year, a fantastic performance when you compare it to gold.
For good measure, gold increased from around US $1,400 an ounce to US $1,900 an ounce over the same period – a percentage increase of 35.7%. If these results are an indication of silver’s utility in falling markets, then one should allocate a small portion of the portfolio to silver in today’s markets, to cushion the effects of a market correction if it happens.