To invest in commodities such as precious metals through mutual funds, Gold Exchange Traded Fund (ETF) was the only option. But after SEBI approved the launch of Silver Exchange Traded Funds, a new avenue has emerged for investors to park money in precious metals.

ICICI Prudential Mutual Fund launched India’s first Silver ETF in January 2022, followed by many other fund houses such as Aditya Birla Sun Life Mutual Fund and Nippon Life Mutual Fund launching their Silver ETFs. In recent times the options to invest in Silver ETFs have widened.

This is, of course, a positive development for retail investors seeking to gain exposure to silver as an asset class to diversify, but here are a few things that you must know…

According to SEBI guidelines, Silver ETFs are required to invest at least 95% of their assets in silver and silver-related instruments i.e. Exchange Traded Commodity Derivatives (ETCDs) that have silver as the underlying asset. The remaining 5% of their total assets may be held in debt or money market securities from liquidity management of the fund.

Given this, Silver ETFs generate returns that are in line with the performance of the price of physical silver, subject to tracking error. Most Silver ETFs are benchmarked against London Bullion Market Association (LBMA) Silver daily spot fixing price. Silver ETFs are directed to own physical silver of standard 30 Kg bars with 99.9% purity confirming the LBMA Good Delivery Standards. The exposure to silver ETCDs should not exceed 10% of the net asset value (NAV) of the scheme. However, the 10% limit doesn’t apply to Silver ETFs if they intend to take delivery of the physical silver instead of rolling over its position to the next contract cycle.

The expectation is that the tracking error of the scheme relative to the performance of the underlying Index will be relatively low. Thus, Silver ETFs are managed by a dedicated fund manager having relevant skill and experience in the commodity market including the commodity derivatives market.

Now many of you might be wondering why to settle for silver when there’s an option of buying a Gold ETF. Well, there are some unique reasons for considering silver as an asset class now and even going forward.

Historically, gold and silver have been considered the most promising precious metals. Their correlation has been more or less linear, which means their prices move in the same direction. However, the quantum of returns for both these metals are dissimilar-thanks to the price fluctuations and underlying fundamentals.

The gold-to-silver ratio best explains the attractiveness of one against another. When the gold to silver ratio climbs above 1, it can be said that gold outperforms silver in relative terms and vice-a-versa.

Graph 1: Gold-to-Silver Ratio

Graph 1

The ratio is calculated considering the Spot gold prices of 10 grams of gold and 1 kg of silver in Rupee terms
(Source: MCX Spot prices, PersonalFN Research)  

As depicted in graph 1, you could buy 690 grams of silver with 10 grams of gold in February 2017. However, now in February 2022, you can buy 780 grams of silver with 10 grams of gold. While the gold-to-silver ratio might look like a simple and straightforward ratio but it demonstrates several traits of two precious metals-gold and silver.

First and foremost, being hard commodities traded globally and denominated in the U.S. Dollar (USD), they share an inverse correlation with real interest rates. The 5-year CAGR returns of gold and silver are 10.9% and 8.1% respectively, but their 2-year CAGR returns are 29.6% and 21.6%, respectively (as of February 17, 2022).

Thus it’s quite evident that ever since the COVID-19 pandemic started and the U.S. Federal Reserve (Fed) slashed interest rates to near zero and expanded its balance sheet, the precious metals turned attractive. Now skyrocketing inflation has kept precious metals still in the race, despite the hawkish outlook of the Fed – which also indicates that these precious metals could be a good hedge against inflation.

But there is one more aspect to consider.

Again, refer to graph 1. Between March 2020 and June 2020, the gold to silver ratio spiked up above 1, which means 10 grams of gold could buy you more than 1 Kg of silver, but from the end of 2020, the ratio slipped. If you juxtapose this with the progression of the pandemic, you will realise that gold shines during times of crisis or uncertainty (due to its trait of being a safe haven and store of value amidst uncertainties) and silver remains distressed. As the clouds of uncertainty disappear and economic activity picks up, silver prices advance.

Graph 2: Contribution of various sectors in gold demand

Graph 2

Data of the year 2021
(Source: World Gold Council, PersonalFN Research)  

The composition of sources of gold demand reaffirms that gold is a reserve asset. The investment part of demand shoots up in times of uncertainty, while higher discretionary incomes push the demand for gold jewellery during strong economic growth phases.

As against that, silver is primarily an industrial metal and is closely connected with the pace of economic growth. Jewellery demand for silver is relatively inelastic as compared to that for gold.

But you might still be wondering why silver ETFs?

Well, you would appreciate that we live in the era of a recycled economy, connected devices, and contactless delivery of goods and services. Silver is an important part of many critical components related to the green, smart and connected world.

So, whether it is solar photovoltaic or 5G or Internet of Things (IoT), or automobile electronics, silver finds extensive applications in their making. In fact, according to The Silver Institute, 21% of the industrial demand for silver in 2021 pertained to the photovoltaic sector.

Table 1: Where does the demand for silver come from?

Demand sources As a % of total demand
Industrial 44%
Net physical investment 22%
Jewellery 15%
Net investments in ETPs 13%
Silverware 3%
Photography 2%

(Source: The Silver Institute Market Review, December 2021, PersonalFN Research)  

Silver Exchange Traded Products (ETPs) have been a recent phenomenon. Higher inflation, awareness about growing silver demand from the sunrise sectors, rising prices, and a tight demand-supply situation seem to be drawing investors to paperless products based on silver.

Globally, the net demand for silver from ETPs stood at 481 million ounces in 2020, and 2021 put together. This is higher than the aggregate demand from ETPs between 2011 and 2019. If this trend continues in the future, silver might well become a proxy for emerging industrial trends.

Table 2: Net investment in Silver ETPs

Year Million ounces (Oz)
2011 -18
2012 53
2013 5
2014 -0.3
2015 -17
2016 54
2017 7
2018 -21
2019 83
2020 331
2021 150

(Source: The Silver Institute Market Review, December 2021, PersonalFN Research)  

What’s the supply situation?

The majority of silver mining facilities are poly-metallic, i.e. silver is mined along with other metals. The share of primary silver mines in 2020 was approximately 27% of the total production of silver, whereas the silver output from lead-zinc and copper mines was 32% and 25%, respectively. Gold mines account for the remaining share.

In the year 2021, the silver market experienced a supply deficit, i.e. demand outstripped supply, for the first time in the last 6 years. In the year 2022 as well, The Silver Institute expects a small deficit.

The longer-term outlook for Silver looks encouraging. But according to World Silver Survey 2021, unless sufficient investments are made over the next 4-5 years, silver production will start declining in the future.

With large economies rolling back ultra-loose monetary policies, money for new mining operations may not come easily. Apart from this, ESG compliance might make it difficult to ramp up mining capacity substantially in a short turnaround time.

In conclusion, it appears that silver ETFs are likely to become more popular going forward. If you have a time horizon of 10 years or more, you might consider investing in them, provided you can deal with price volatility. Keep in mind, unlike gold, silver is highly volatile, which means a negative event could weigh down on the price of silver. Therefore, silver ETF returns could be lumpy – with sharp up and downward movement.

The 7-day volatility in silver and gold prices over the last 5 years has been just 0.27% in Indian Rupee (INR) terms but that doesn’t reflect the wild swings silver prices have exposed investors to in the interim. Silver prices have swung more than 10% in a week on multiple occasions, and this is colossal as compared to the relatively moderate deviations in gold prices.

Thus, even if you have a high-risk appetite and a suitable time horizon, restrict your exposure to Silver ETFs to 5% of your total investment portfolio.

This article first appeared on PersonalFN here


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