Eric Dutram: The minutes of the most recently concluded Federal Open Market Committee (FOMC) meeting has attracted mixed reactions from the investor community. The minutes hinted towards a possible decrease in or even an end to the quantitative easing of $85 billion a month by the Federal Reserve.
Precious metals, especially gold and silver received a solid boost last fiscal year when the Fed announced an open ended mortgage backed securities purchase program up to the tune of $40 billion a month known as QE3. While it is true that the move resulted in rocketing gold and silver prices initially, the prices now have fallen substantially, especially over the final quarter of fiscal 2012.
Although both gold as well as silver do belong to the precious metal asset class, investments in silver are quite different (if not completely different) from that of gold which acts like a value store investment proposition and an ultimate safe haven.
However, considering the investment case for silver, what makes this white metal so unique as well as weird is its dual nature of serving two purposes. Firstly, like most precious metals silver investment is considered to be a store of value, and secondly, due to its vast industrial usage worldwide silver also has a high correlation to the broader economic sentiments.
What this means is that silver prices receive a boost every time industrial activities pick up during positive economic conditions. This is mainly because strong economic fundamentals facilitate growth which in turn increases industrial production. Due to the industrial usage of silver its consumption demand increases thereby raising its prices.
Furthermore, the positive economic activities also cause the capital markets to tread in an upward direction, consequently increasing its valuation. Therefore it is prudent to note that equities and silver do have somewhat of a positive correlation among each other which actually increases during times of stock market surge. (see Best and Worst ETFs to Start the Year)
Surprisingly, even gold has exhibited a positive correlation with the equities, just like its white counterpart. The correlation between gold and equities tends to increase during times of stock market surge. However, the strength of this positive correlation is stronger in case of silver than gold. One reason which explains this characteristic of silver is its high volatility. SLV has a volatility of 35.63%, compared to this GLD has a volatility of 17.5% and the S&P 500 18.52% in a similar time frame.
However, the positive relationship with equities and gold does not hold true in times of stock market plunge. The reason for this is the safe haven nature of gold investments. When equities go for a toss, investors actually buy gold as a safe haven investment thereby completely scrapping the positive correlation that these two asset classes which were in place when the equity markets surged.
Of course, silver being a precious metal is also bound to follow suit, however, the magnitude of this inverse relationship between silver and equities during a stock market plunge is much lower than that of gold. This happens primarily due to the linear (i.e. positive) dependence of silver prices on the broader economic conditions as discussed earlier. (read Q4 ETF Asset Report: Broad Market ETFs Reign)
The following representation quantifies the relationship between the three entities completely supporting the inferences mentioned in the above paragraphs. The iShares Silver Trust (NYSEARCA:SLV), the SPRD Gold Trust (NYSEARCA:GLD) and the S&P 500 have been used as buffers for prices of silver, gold and equities respectively.
|Data Points||GLD||SLV||S&P 500|
|GLD/SLV||SLV/S&P 500||GLD/S&P 500|
|1 year Rolling Correlation||GLD/SLV||SLV/S&P 500||GLD/S&P 500|
As is quite clear, the correlation between the precious metals and equities tends to increase when the broad equity markets witness a surge. As an instance, in the past three years, the correlation between the precious metals and equities has surged every time the equity markets have witnessed a bull run. The most recent example being the equity market surge when the Federal Reserve announced QE3 in mid September last year which also boosted commodity prices across the board.
At this time the correlation between SLV and S&P had touched a maximum of around 54% while the correlation between GLD and S&P reached a high of 40.39%. On the contrary when the equity markets witnessed a plunge during the latter part of the fiscal year 2011 over issues surrounding the sovereign debt crisis, the correlation between the precious metals have witnessed a plunge. (see Gold ETFs Make 2012 Another Positive Year)
During these times, the correlation between silver and equities reached a minimum of 5.73% while gold and equities were negatively correlated (due to the ultimate safe haven nature of gold) with a minimum correlation of -20.32%. However, the two precious metal siblings also exhibit a strong bonding between each other. In fact their correlation has never gone below 73% while reaching a maximum of almost 85%
Nevertheless what is most noteworthy in this exercise is the fact that the correlation between silver and equities has never fallen below 0. In other words, at all times silver exhibits a positive correlation with equities no matter how weak the positive correlation is. Thus, although silver belongs to the precious metal asset class, it has a soft corner for equities which makes silver the ‘Equity’ like precious metal.
For investors seeking to play this intriguing precious metal the following ETFs could be solid long term choices. This is especially so in consideration of our bullish outlook for silver as indicated by the Zacks Rank of 1 or ‘Strong Buy’, for each of these ETFs.
iShares Silver Trust (SLV) which tracks the price of silverbullion is by far the biggest and the most popular silver ETF. It has an asset base of around $9.9 billion and an average daily volume of close to 11.5 million shares. The ETF charges investors 50 basis points in fees and expenses and has returned 5.77% for the one year period as on 31st December 2012. SLV has a Zacks Rank of 1 or ‘Strong Buy’.
Another ETF which tracks the price of silver bullion is the ETFS Physical Silver Shares (NYSEARCA:SIVR). However, one thing that sets this ETF apart from its iShares counterpart is its relatively lower expense ratio of 30 basis points. The ETF was launched in July of 2009 and since then has been able to amass an asset base of about $560 million. The ETF has an average daily volume of around 246,000 shares. SIVR too, has a Zacks Rank of 1 or ‘Strong Buy’.
PowerShares DB Silver ETF (NYSEARCA:DBS) is a futures backed ETF which tracks the DBIQ Optimum Yield Silver Index Excess Return. Like its counterparts, DBS has also managed to earn a Zacks Rank of 1 or ‘Strong Buy’ for itself (read Zacks Top Ranked Silver ETF: DBS).The ETF is pricey with an expense ratio of 79 basis points given its futures backed structure. It has an asset base of around $64 million with an average daily volume of around 16,000 shares.