Diversity is the spice of portfolio, add some gold and silver

Have you been investing in the Indian equity markets directly via stocks or indirectly via mutual funds? Then you know how good things have been in the last few years. The post-pandemic bull run has taken markets to new highs, and has also made a lot of wealth for the investors.

Everyone hopes that the party will last forever. However, the fact is that in markets, mean reversion is always possible. Theoretically, this means that asset prices will eventually return to their long-term mean or average. And when that happens, there can be long periods of poor or no returns. New investors who have joined markets in the last five years would know this. But if you look back at history, then you will see that once every few years, equities can give negative returns as well.

This is one reason why almost everyone should have different assets in their long-term portfolio. For salaried people looking to save for retirement, the debt part is well handled via their provident funds and NPS, etc. For equity, there is a growing interest in investing in equity mutual funds via SIPs.

A case for precious metals

To increase the robustness of the portfolio, there is a case to include precious metals in the mix. There are various precious metals that one can invest in, but in this article, let us look at gold and to some extent, silver. But do you understand how gold and silver prices move?

Unlike other popular assets like equity or debt, precious metals like gold don’t have embedded cash flows. So, it is not possible to put a valuation multiples on them in purely financial terms.

Gold

Generally, gold and silver prices are dependent on the metal’s prevalent demand-supply equation and other factors like the current state of the global economy, ongoing geopolitical events, etc. The gold prices have a habit of staying dormant for extended periods, and then show sudden spurt in prices. Gold also serves as a good hedge against inflation. Also, it tends to have a low correlation with other asset classes like equities which helps its case as a portfolio diversifier.

Silver

Coming to silver, it isn’t just a precious metal. It also has several industrial use cases. And how do silver prices move? The silver prices tend to be far more volatile than gold. In times of economic uncertainties, silver along with gold acts as a safe haven and a proper hedge. But during normal times, it tends to act like pseudo-base metals with industrial demands. It won’t be wrong to say that silver prices are linked not only to prevailing uncertainties but also to the global economic growth in related sectors/industries.

Is gold the go-to option?

When we talk about investing in precious metals, the general tendency is to consider gold as the go-to option. But is it enough? Is gold alone a sufficient diversification within the precious metal bucket? For most people, the answer is “Yes”. We will come to that in a bit.

Let’s see how much allocation to precious metals should investors have in their portfolios.

In my view (and many commodity traders might not agree) is that precious metals like gold and silver are not core assets. At best, they are portfolio diversifiers and hence, should be treated as that when it comes to allocation in portfolios.

If you have a very small portfolio, then you should first focus on equity and debt alone and let your portfolio size build up first.

For others with comparatively larger portfolios, having a 5-15% allocation to precious metals can be considered. Anything below 5% doesn’t always help much to move the portfolio needle. Anything beyond 15% will open the portfolio to relatively large risks associated with volatile movements of precious metals once every few years.

So, the range of 5% to 15% is a comfortable one for most investors.

This much gold and that much silver

Frequently you will see that the prices of both gold and silver will move in similar directions, but generally, gold is much better insulated during economic slowdowns and silver isn’t (due to its use cases in various industries). Also, gold often shows a deeper negative correlation with economic growth while silver has a weak positive correlation to the same.

From a portfolio diversification perspective, giving more weightage to gold is advisable. Let’s say you want a 10% allocation to precious metals, then 7-10% to gold and a smaller 0-3% to silver is suggested. And as I said earlier, skipping silver is perfectly fine for most people as gold’s allocation alone is sufficient.

If you already have some allocation to gold/silver, then you are fine and more importantly, you already know why these should be part of the portfolio.

But what about those who don’t have any allocation to precious metals?

For such people, first of all, there is no need for a knee-jerk reaction. Try to gradually scale up your gold allocation to 5% first. Once that level is achieved, then consider whether you need to increase it further to 10-15% or not. A competent investment advisor can help you decide what is right for you if you are not sure yourself. Don’t try to copy your friends/ family as most of them don’t know what they are doing themselves!

Disclaimer – Please don’t consider the above discussion as investment advice. Everybody’s financial goals and requirements are unique. So please talk to your investment advisor before investing in gold/silver or other assets.

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