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Trading asset is trading people. Each asset class has its appeal - be it transitory or permanent - to different groups of investors, and those investors drive the price up and down. Silver isn't an exception to the rule.

There is a saying that silver is the poor man's gold. But that only reflects one aspect of silver - being a precious metal. Silver also has broad industry use. It conducts electricity well and is used in all kinds of electrics. It is also an important catalyst enabling many industrial reactions.

Even gold attracts a different group of investors.

Some investors buy gold to preserve value in anticipation of inflation. Their thesis is when all central banks are printing paper money like there is no tomorrow, gold is the real money that never depreciates.

Other investors see gold as a safe-haven investment. Gold was bid up as the only shelter when waves of the European debt crisis hit.

For its industry use, the silver price is seen to be tied to economic growth. Again, we can differentiate growth into two types: developed world and developing world.

Growth in the developed world is, generally speaking, driven by consumption where electrics constitute a big portion. As said, electrics are directly linked to silver. For example, someone has calculated that on average one cell phone contains 0.35 grams of silver.

On the contrary, manufacturing is the engine of growth in the developing world. Although among the famous BRIC countries only China is the "global factory," Russia and Brazil are largely suppliers of energy and raw materials. Without manufacturing, there will be less demand for energy and raw materials, thus less growth for Russia and Brazil.

To summarize, silver has the following attributes:

  • Poor man's gold - GLD
  • Inflation protection - TNX and TYX
  • Safe-haven investment - 1/RUT and VIX
  • Growth in developed world - COMPQ
  • Growth in developing world - SSEC

To quantify each attribute's appeal, we calculate silver's correlation to the representative asset classes listed above. If the correlation between asset class A and B is X%, it means that X% of A's price action can be explained (linearly) by B, and vice versa.

We use iShares Silver Trust (SLV) to represent silver's price action, and SPDR Gold Trust Shares (GLD) to represent gold's. We use 10-Year Treasury Note Yield (TNX) and 30-Year Treasury Bond Yield to represent inflation.

Safe-haven investment is a little bit involved as there seems to be no permanent safe-haven investment. When the euro was on the brink to bust, gold was seen as the safe haven. But when the U.S. economy was stable, Treasury Bonds were considered as well.

We think a safe-haven investment consists of two components: low risk appetite and great fear. For the former, we choose Russell 2000 Small Cap Index (RUT). Small companies are more vulnerable during economic difficulty and investors run away when risk appetite is low. Actually we use 1/RUT, i.e., the reciprocal of RUT, because RUT is expected to rise when risk appetite is high. For fear, we choose Volatility Index (VIX), the infamous "investor fear gauge."

For developed world growth, we pick Nasdaq Composite Index (COMPQ) for its heavy weight on hi-tech names, which are often growth plays. For developing world growth, we pick the Shanghai Stock Exchange Composite Index (SSEC). The reason is that, as discussed before, China is the global factory and developing world growth is largely driven by manufacturing.

1 Year Correlation Between

SLV

SLV

100.00%

GLD

10.94%

TNX

35.44%

TYX

45.15%

1/RUT

-22.83%

VIX

-7.14%

COMPQ

13.02%

SSEC

56.50%

Hence our conclusion:

  • Given the low correlation between SLV and GLD, it is unjustified to call silver the poor man's gold
  • SLV is neither likely a safe-haven investment, for its negative correlation to 1/RUT and VIX
  • SLV is somewhat responsive to inflation as shown by its moderate correlation to the yield of Treasury bonds.
  • SLV is less reactive to developed world growth, given its low correlation to COMPQ
  • Developing world growth, represented by SSEC, is the key driver behind sliver.

It appears that silver is more an industry metal and less a precious metal. And silver investors better keep an eye on the Shanghai Stock Exchange.

Source: What Is In The Silver?