Silver Linings Playbook

by: Eric Parnell, CFA

Gold has been shining as of late.

Still interested in precious metals but reluctant to buy gold at overbought levels?

This precious metals alternative may be worth a look.

Gold has been shining bright as of late. After fading for much of 2019 since mid-February following an initially strong start to the year, gold has suddenly burst to life over the past four weeks. Since bottoming on May 21 at $1,269 per ounce, gold has surged by more than +10%. In the process, the yellow metal managed to trade above $1,400 per ounce for the first time in nearly six years. This marks gold’s latest upside progress, having now increased by roughly +34% since bottoming in late 2015 at $1,045 per ounce.

No shortage of reasons for gold to climb. It is arguably more perplexing that gold has languished for as long as it has over the past six years. Gold is an alternative global reserve currency with a history of being used as money dating back nearly threemillennia. And with major global central banks including the U.S. Federal Reserve making a complete and total debauchery over the past decade of the fiat currency system that dates back less than five decades, such is the time in recent years when one might reasonably wish to own gold as a store of value. But with mounting geopolitical and economic instability coupled with the recent apparent total capitulation by global central banks that they are effectively bound to be easy to the end (whatever this final end may be) seemed to be too much to keep this good precious metal down any longer.

What if you missed the recent gold rally? While I could certainly make the case for gold to continue to rise much further from here. I could particularly make this case in a world without policy interventions and where all assets classes and categories are afforded comparable regulatory oversight. But it is understandable that investors might be reluctant about buying gold following its recently strong run over the past month, particularly since the yellow metal is now trading at its most overbought readings in several years.

What alternatives, if any, might an investor consider that wishes to add incremental precious metals exposure to participate in continued upside while managing against the risk of buying a metal now trading at multi-year highs?

Silver may be worth a look. While gold has been in recovery mode for the past few years, the same cannot necessarily be said for silver. This precious metal “baby brother” alternative to gold has historically traded with a high correlation to gold. It also shares a recent bottom that came at essentially the same time at the end of 2015 into the start of 2016.

But a notable divergence has taken place between these two precious metals in recent years. Since mid-to-late 2017, while gold has trended gradually higher, silver instead has drifted gradually lower.

What accounts for this recent divergence between gold and silver? Unlike gold that is more purely a precious metal, silver has industrial applications to go along with its status as another alternative global reserve currency. As a result, it goes through phases where it trades like a precious metal followed by spells where it trades like an industrial metal. And in mid-to-late 2017, it shifted toward trading with a higher correlation to copper than gold.

Why silver in mid-2019? Over the past year, silver has been showing an increasing trend toward taking back up its precious metal identity. For since global financial markets started to become unsettled in September of last year, silver started to ditch its industrial metals path and resumed trading with its historically high correlation to gold.

Why silver may be poised to close the gap with gold to the upside. Another longer term characteristic that adds to the silver appeal at the present time is the fact that the silver-to-gold price ratio is trading at its lowest reading in nearly three decades. Put more simply, silver has not been as cheap as it is today relative to gold since the early 1990s.

The bottom line. If you missed the recent run up in gold prices but have interest in a potential precious metals allocation given all that continues to unfold geopolitically and economically, investors may be well served to consider silver. It is not only resuming its precious metals trading identity, but it currently represents a historically attractive bargain relative to gold.

Important caveat. Those considering owning silver should consider the following carefully before taking any action. Silver is an investment that is not for the faint of heart or the risk averse. Gold is a higher risk investment in its own right with a historical price standard deviation approaching 18%, and silver trades with nearly double the price volatility with a historical standard deviation approaching 32%. As a result, those pondering an allocation to silver must have a higher risk tolerance. Moreover, any allocation to silver should be limited to a relatively small allocation within a broader diversified portfolio context. For most investors, save the most aggressive or those with a particularly strong conviction in silver, this portfolio should be limited to 1% or 2% at most.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners and Global Macro Research makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners and Global Macro Research will be met.

Disclosure: I am/we are long PSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.