Gold Vs Silver: Better Fundamental Value In Silver
Philip Baker | Apr 26, 2015 01:33AM ET
Gold vs silver: better fundamental value in silver, but more short term price risk?
Gold and silver have been in an overall uptrend since 2008. Over the last 6.5 years, gold has returned an average 9.0% pa with a volatility of 18.8%. Silver has returned 15.4% pa. over the same period with a volatility of 35.2%.
The respective return/volatility ratios have been 47.8% and 43.8% suggesting that gold has slightly outperformed silver on a risk-adjusted basis.
We thought we would investigate which of the two commodities currently represents better value, based on a fair value assessment. The fair value of the commodities is based on a multiple regression analysis of their price on 22 driver variables including interest rates, stock indices, other commodities and exchange rates. The database is 6.5 years of daily prices sourced from eoddata.com.
The regression coefficients are multiplied by the current prices of the driver variables. Added to the intercept this gives a current estimate of fair value.
The driver variables for the gold price model, and the sensitivity of the fair value to those variables, is shown in the graph below –
The positive correlation to the bond index (and negative correlation to the 30 year bond rate) is not surprising given that higher interest rates increase the opportunity cost of holding gold. This effect is exacerbated by the strengthening of the USD that could be associated with higher US interest rates.
For silver, we have:
(The gold/silver index is the PHLX Gold/Silver Sector index of gold and silver mining companies: ticker XAU.)
The opposite impacts of US dollar index movements on gold (negative correlation to USD) and silver (strong positive correlation) can be seen from the above two graphs.
The current fair value of gold using this model is $1251, which is 4.8% above the current price of $1194. The fair value of silver using this model is currently $18.08, which is 14.2% above the current price of $15.83.
Get The News You Want
This analysis suggests that silver is currently better fundamental value than gold, with neither being assessed as overpriced.
We can also make an attempt at estimating the short term price movement in each commodity using a lead indicator approach. The PHLX Gold/Silver Sector index has fitted reasonably well in this regard (to both indices) over the last 6.5 years. We assessed the relationship between six-week returns on XAU and subsequent six week price movements of gold and silver. Based on the movement in XAU over the last six weeks, we have a projected decrease in the gold price over the coming six weeks of 1.7% with 4.0% decrease in the silver price.
Given that silver has the more volatile price, this suggests that for the short term, gold is the better option. A long gold/short silver pair trade would hedge out some of the downside in both commodities, but would be exposed to unanticipated US dollar strength.
A trading strategy based on the lead indicator model opens up the possibility of an alternative investment offering valuable diversification to a US-centric stock portfolio. Allocating 10% to gold traded using the lead indicator model would have increased the annualized return/volatility ratio from 101.2% (100% S&P 500) to 113.1% over the last 6.5 years. An allocation of 10% to silver would have given 110%. Allocating 5% to each of gold and silver would have provided a ratio of 112%.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.