Precious metals such as silver, platinum and palladium are a way to diversify one’s portfolio, away from a single precious metal. Although they are often correlated to gold, they have their own independent demand and supply dynamics.
While gold is at $1,717 (as of 3 June 2020) per ounce close to its all-time high of $1,900 per ounce, silver has fallen dramatically behind. It is currently trading at $17.77 per ounce, significantly behind its peak of $48 in 2010.
“Silver is held both as a precious metal and for a host of industrial uses, unlike gold, which is widely held as a precious metal for investment purpose. Silver has a smaller market compared with gold in terms of buyers, and hence it reacts faster compared with gold. Investors, therefore, track gold/silver ratio to invest in silver when they find silver is available much cheaper than gold. The recent price rise in silver has lowered the gold/silver ratio to 96 from the record high of 124 with silver rallying nearly 19% in May,” said Deepak Jasani, head of retail research at HDFC Securities.
Brokers in India allow you to open commodity trading accounts, just like you can trade in the equities. However, there are a number of things you should consider.
First, you can only buy futures and options contracts in metals. These have a life of a month. There are no silver or platinum ETFs, unlike the gold ETFs that are backed by physical gold in India. Second, there is a minimum lot size and minimum investment amount. “The one-kg silver micro contract is the smallest silver derivative,” said Venu Madhav, chief of operations at Zerodha.
The price of one kg of silver is around ₹43,000, making this approximately the minimum amount you will need to invest. Third, brokers do not take the entire purchase price upfront, but instead, take a ‘margin’ amount. This is usually 10% but fluctuates according to the volatility in the precious metal. You also have to pay brokerage.
“The brokerage charge usually resembles the F&O charge structure of the stockbroker. At Zerodha, the brokerage for commodity derivatives is 0.03% or ₹20 per executed order, whichever is lower,” said Madhav.
Fourth, the futures price of the metal may trade at a premium or a discount to its spot price and this can eat into your profits. A premium to spot is called ‘contango’ and a discount is called ‘backwardation.’ Fifth, there is liquidity only in the near month contract (contract closest to your trading day). In theory, you can keep buying fresh futures contracts when the old ones expire.
However, this creates a cost to you called carry cost because the new contract trades at a different price from the expiring contract. Jasani put the current average roll cost at 5% per annum, although this is partially offset by the fact that you only deposit a margin amount with the broker. The rest of the upfront price you would ordinarily pay for, say physical silver, can be invested in a liquid fund. Finally, there is mark-to-market cost, pointed out Feroze Azeez, deputy CEO, Anand Rathi Private Wealth.
This is the erosion of your margin money when there are large swings in the price of the metal. Rathi suggested that HNIs can avoid all the costs and complexities of exchange trading by simply getting large brokerages to design structured products for them. These products participate in the upside of a commodity to a limited extent but in return do away with the costs of exchange trade.
Given the many complications of exchange trading of precious metals, investors can go down the mutual fund or ETF route. Some mutual funds in India have exposure to the stocks of mining companies, which are in turn linked to the price of precious metals. For example, DSP World Mining Fund invests in mining stocks globally. It was launched in 2009 and has delivered a CAGR of -0.78% since launch. However, the fund rallied strongly after 2016 and its three-year returns have been a more respectable 11.94% CAGR.
However, the prices of mining companies are not perfectly correlated with the concerned metal. For example, profits can be affected by strikes and lockdowns in their respective operations.
Finally, investors can invest in ETFs listed in the US if they have foreign brokerage accounts. You can read more about how to set up such accounts and the various considerations it involves here.
These ETFs also invest in the stocks of mining companies or in some cases simply hold the physical metal. According to Viram Shah, CEO of Vested Finance, a US Securities and Exchange Commission (SEC) registered investment advisor, US-based ETFs like iShares Silver Trust (SLV) and Aberdeen Standard Physical Palladium Shares ETF (PALL) are the best options for investing in silver and palladium, respectively. Both ETFs are backed by physical holdings of the metals and have expense ratios of 0.5% and 0.6%, respectively, according to Shah.
Precious metals investment is not for the faint of heart. It requires a high-risk appetite and a high degree of financial knowledge.
“I regard silver as a product for sophisticated investors only. By sophisticated I mean those who fully understand the risks of investing,” said Bhavesh Damania, founder and chief care taker, Wealthcare Investments. “If an investor wants to invest in it, it shouldn’t be more than 5-10% of the portfolio and with risk appetite and patience to wait till it delivers decent returns.”
However, those with money and knowledge can diversify a part of their gold portfolios into other precious metals. This can reduce risk and improve returns if these commodities play catch up. For those who are comfortable with the complexity of various electronic modes of investment, the physical purchase of precious metals like silver remains an option.