– Silver, platinum and palladium see increased role as investment vehicles
– Increase in academic output on the white precious metals is in line with this
– Silver and particularly gold are safe haven assets
– Silver was a safe haven at times during which gold failed to be
– Platinum and palladium less so but have diversification benefits
– Silver manipulation is possible and indications of, if not legal proof
– Benefits platinum and palladium could provide as money not been fully addressed
– Main focus in investment drivers is price – not on drivers of physical demand
– Platinum, palladium and silver have different relationships with other assets and divergent abilities in hedging risk
– White precious metal investors should employ a buy-and-hold strategy
– Silver markets have become more efficient since 1977
– White precious metals are increasing in investment importance
– Research shows hedging role and diversification benefits of precious metals
by Jan Skoyles, Editor Mark O’Byrne
A review of the academic literature on the financial economics of silver, platinum and palladium has recently been conducted by Vigne, Lucey, O’Connor and Yarovaya.
The review surveys and covers the findings on a wide variety of topics in relation to the White Precious Metals including Market Efficiency, Forecast-ability, Behavioral Findings, Diversification Benefits, Volatility Drivers, Macroeconomic Determinants, and their relationships with other assets.
For those asking whether or not they should invest in precious metals or to increase their allocation, it can be of use to read some academic research into the role the white metals can play in hedging risk in their investment and pension portfolios. There are many strongly held opinions regarding gold and silver and precious metals and some mathematical and economic analysis can go a long way in helping us to understand how and why we should consider investing in these less popular precious metals.
How efficient are the white metal markets?
Given that silver is traded 24 hours a day, across the globe one would, argue the authors, expect to find a market that is ‘constantly involved in price discovery and adhere closely to the Efficient Markets Hypothesis’. This expectation has lead to a number of studies seeking to address this question.
Below we summarise the authors’ findings. The papers featured look at not only the efficiencies of the markets but the effectiveness of futures markets at predicting spot prices and also market manipulation.
Key findings across the literature, relevant for investors include:
- Speculation in silver
Solt and Swanson’s (1981) research – soon after silver’s massive bull market in the 1970s which propelled prices from below $1.50/oz to nearly $50/oz – led them to conclude that silver markets are more speculative than other investment markets - What role do futures markets play in making predictions?
Varela’s (1999) regression model finds closest to delivery silver futures are a good predictor of the future cash price, showing efficient links between these markets - Mutafoglu et al.’s (2012) work looks at whether open futures positions can predict platinum and silver spot prices movements. They find that white precious metal market returns explain trader’s positions
- How efficient? More efficient
Charles et al. (2015) looks at the efficiencies of both the daily spot prices of platinum and silver between 1977 and 2013. They find that that the markets have gradually become more efficient during this period - Silver price manipulation
Silver price manipulation is a hot topic among investors and banks have been guilty of manipulating the gold and silver markets in recent years and so it is something important for academics to study. Batten et al. (2016), looking at the 5 minute tick data between the 1st of January 2010 and the 30th of April 2015, finds evidence of ‘possible manipulation’ but warns that the ‘evidence provided is merely indicative and not a legal prove for foul play’ - Exogenous shocks – gold or silver?
Looking at silver prices between 1975 and 2013, Gil-Alana et al. (2015a), find shocks send silver higher but ‘exogenous shocks will affect real silver prices less intensely than gold prices’ - The impact of ETPs and precious metal and gold ETFs.
Fassas (2012) finds a significant correlation between silver returns and the flows into silver Exchange-Traded Products exists and further find that ETP flows are a driving factor for platinum and palladium prices - When it comes to the Global Financial Crisis, we know that gold deviated from its fundamentals but Figuerola-Ferretti and McCrorie (2016) find that in the same period silver and palladium were rather affected by the launch of ETFs rather than the financial crisis as such.
- Which trading strategy should I use?
By examining the daily price of silver between January 1968 and March 2016 and the daily price observations of platinum and palladium between April 1990 and March 2016, Almudhaf and Al Kulaib (2016) conclude that a traditional buy-and-hold strategy outperforms an attempted market timing strategy
Pricing data
There has been a lot of work done by academics trying to model price data. For some investors it will not add much to the conversation. However there are a couple of key takeaways from the review:
- Silver twice as volatile as gold; gold not that volatile
Morales and Andreosso-O’Callaghan (2011) ‘the standard deviation of daily silver returns is more than twice the standard deviation of gold and if the precious metals only palladium has a higher standard deviation than silver.’ - Caporin et al. (2015) find that ‘platinum is found to be the least liquid and least volatile metal of the precious metals considered.’
How should I split my portfolio?
Since 2003, we have recommended that investors hold precious metals as part of a balanced, diversified portfolio. But that doesn’t mean there is a simple answer for how much you should hold.
- Silver low correlation with stocks
Jaffe (1989) finds that silver prices between 1971 to 1987 had a “very low correlation of 0.134” with stocks showing its “usefulness in a diversified portfolio.’ - Silver as a portfolio hedge
Kocagil and Topyan (1997) uncover ‘a positive relationship between risk premium and daily futures trading and to a negative relation- ship with the S&P 500, pointing towards silver’s role as an portfolio hedge.’ - A long-term portfolio hedge
McCown and Zimmerman (2007) find that ‘silver is a less volatile investment than the market in the short- run, and that it moves in opposite direction than the market on the long-run – arguments in support of silver’s ability to be used as a hedging tool against stock markets.’ - Platinum or silver?
Belousova and Dorfleitner (2012) conclude that ‘Adding silver or platinum to a portfolio [of stocks, sovereign bond and the money market instruments] during bull markets reduces volatility and enhances return. During bear markets silver only reduces portfolio risk…but platinum loses its diversifying ability.’ - A higher proportion to gold
Hammoudeh et al. (2013) when looking at different make-ups of portfolio decides ‘an optimal portfolio should hold a higher proportion of gold than any other asset (even though silver was the best performing asset over the time frame observed), and that overall, the pure precious metal portfolio proved to be the least efficient’ - During tough times hold silver, gold and platinum
When looking at periods of high volatility and poor returns of stock markets, Hillier et al. (2006) concludes ‘silver’s hedging abilities were found to be to be stronger than those of platinum.’ But this was not the recommendation ‘when looking at what metals to optimally hold in a portfolio, silver did not perform as well as both gold and platinum which scored higher returns over the period.’ - Financial stress
Reboredo and Uddin (2016) when looking at the impact of financial stress and policy uncertainty finds that ‘financial stress has a positive effect on gold and silver prices, in contrary to platinum and palladium’ - Which one is the safe haven?
When looking at all four precious metals’ role as a safe haven between 1989 and 2013, against the S&P 500 and US 10 year bonds, Lucey and Li (2015) find that ‘silver was a safe haven at times during which gold failed to be, but also during far more quarters than both platinum and palladium. Empirically however, gold should be considered the better safe haven investment for it acts as one more often than white precious metals.’
What happens when there is volatility?
- Silver is sensitive in the short-run
Hammoudeh and Yuan (2008) find that between 1990 and 2004 ‘silver is found to have a low sensitivity to bad news in the short run, giving it safe haven like qualities. Increases in interest rates reduce silver price volatility. Oil price shocks have the effect of cooling precious metals volatility, making them good diversifiers in a commodity portfolio.’ - Are macroeconomic factors important?
Chen (2010) finds that ‘the importance of global macroeconomic factors in explaining silver and platinum price volatility has increased over the time period observed…A similar picture is observed for platinum.’ - The metals affect one another
Sari et al (2007) finds that ‘over the long run gold accounts for 16% of silvers variance’ in a similar vein Lucey and Tully (2006) find ‘silver is found to explain 23% of gold price volatility. In the short-run, unexpected shocks to gold, platinum and palladium prices have a positive and significant impact on the price of silver and vice versa. Silver explains about 10% of the variations of both platinum and palladium prices, while platinum and palladium explain about 22% of their respective price fluctuations.’ - The silver price means little to platinum and palladium
However Balcilar et al. (2015) disagree with Sari et al (2007), they find ’the impact of change of the gold price on silver is about 1.25%; against an impact of about 0.07% from silver on gold. The impact of change of the gold price on both platinum and palladium is of about 0.8%, while the impact of change of silver prices is practically non-existent for both platinum and palladium prices.’
How does the macroeconomy affect the white precious metals?
- Platinum and palladium in the long-run
Using data from 1914 to 1996 to assess the inflation hedging ability of the white precious metals Taylor (1998) finds that platinum and palladium ‘served as a long-run inflation hedge, while evidence also points towards the short-run hedging abilities of platinum.’ - Silver good in the long and short-run
Adrangi et al. (2003) finds there is ‘a positive relationship between silver and the CPI in the long-run and the short-run is observed.’ - Two factors driving the silver price before 1989
Radetzki (1989) concludes ‘that two factors drive the price of silver: demand from industry and private inventories. Oil prices and official inventories are not believed to be amongst the major driving forces of the silver price, even though they are seen here as important in determining the price of gold.’ - Negative impact on silver prices
Elder et al. (2012) look at the impact of US macroeconomic news announcements on the return, volatility and trading volume of gold, silver and copper futures. ‘Advance retail sales, changes in nonfarm payrolls, durable goods orders, business in- ventories, construction spending, and new home sales announcements have a statistically significant negative influence on silver futures prices; only trade balance announcements are positively associated with silver futures prices.’ - Silver doesn’t worry about monetary nor financial market variables
Batten et al (2010) ’neither monetary nor financial market variables are significant for silver price volatility. Instead, the volatility from the other precious metals markets has an effect on silver price volatility.’ - Silver has a strong relationship with US factors
Fernandez (2017) ‘On a monthly basis, a strong relationship is identified between white precious metals and US industrial production as well as US monetary supply…a very strong relationship is identified between the prices of gold and silver on a weekly basis during bullish environments, while platinum and palladium have a strong relationship with silver during bearish periods.’ - The white precious metals are increasing in importance
Fernandez (2017) also finds that ’the rise in importance of the price of white precious metals and consumer confidence and exchange rates in the United States, [is] in line with the rise in importance of white precious metals as an investments asset.’
Conclusion – White metals have a key role to play
When we are told that we should invest in precious metals then we primarily think of gold and silver. The truth is, that we should consider platinum and palladium which are, like silver, industrial commodities and can play a significant and beneficial role in portfolio diversification.
As we have seen, there is not as much research into the white precious metals and their role as investments as there is for gold. However, given the increasing demand for them we are now reading far more research. This suggests that they will continue to play not only a key role in investment portfolios but in the wider macro-economy.
There is a strong case for having an allocation of some 20% to 30% of an investment or savings portfolio in physical precious metals. The majority of this should be in gold and silver but as we have seen the academic research shows that having smaller allocations – maybe 5% and 5% – to platinum and palladium – will also have diversification benefits.
Investors would be prudent to consider an allocation to all four precious metals, and rebalance when there is outperformance, in order to maximise the safe have aspect and return of their portfolio.
Download and Read ‘The Financial Economics of White Precious Metals – A Survey’ here
News and Commentary
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How Western Civilisation Could Collapse (BBC.com)
How Miners Dig for Gold Miles Underground (Bloomberg.com)
Alarm Bells Start Ringing for U.K. Economy (BloombergQuint.com)
Gold Prices (LBMA AM)
21 Apr: USD 1,281.50, GBP 1,000.85 & EUR 1,197.31 per ounce
20 Apr: USD 1,279.90, GBP 996.91 & EUR 1,188.00 per ounce
19 Apr: USD 1,282.05, GBP 999.74 & EUR 1,196.79 per ounce
18 Apr: USD 1,285.00, GBP 1,025.82 & EUR 1,205.46 per ounce
13 Apr: USD 1,286.10, GBP 1,025.28 & EUR 1,208.42 per ounce
12 Apr: USD 1,272.30, GBP 1,018.22 & EUR 1,199.02 per ounce
11 Apr: USD 1,255.70, GBP 1,011.47 & EUR 1,183.75 per ounce
Silver Prices (LBMA)
21 Apr: USD 17.98, GBP 14.05 & EUR 16.80 per ounce
20 Apr: USD 18.19, GBP 14.21 & EUR 16.91 per ounce
19 Apr: USD 18.22, GBP 14.19 & EUR 16.99 per ounce
18 Apr: USD 18.42, GBP 14.56 & EUR 17.27 per ounce
13 Apr: USD 18.56, GBP 14.80 & EUR 17.45 per ounce
12 Apr: USD 18.31, GBP 14.65 & EUR 17.27 per ounce
11 Apr: USD 17.94, GBP 14.44 & EUR 16.91 per ounce
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