IAUM - GLD And SLV: My 2023 Precious Metal Outlook

Summary

• My 2023 outlook for the precious metal, gold and silver especially, can be summarized in one word: glitter (pun intended).
• I see a set of reasons and will elaborate on 3 of them in this article to explain why they are well-positioned to glitter.
• To make the outlook more actionable for ordinary investors, I will anchor the explanations using the SPDR Gold Trust ETF (GLD) and iShares Silver Trust ETF (SLV).
• I will illustrate how I use these ETFs to hedge against current macroscopic risks and profit from the silver-gold trade.

Thesis

An often-asked question in our marketplace service involves our precious metal holdings, specifically gold and silver ETFs. For readers who cannot wait, our specific holdings are listed at the end of the article, with a 2022 review and 2023 outlook provided in our recent blog article . The question came in different forms and it would make the article too long to include all its variants. So, the thesis of this article is limited to the most actionable form: why are we are still allocating a good part of our portfolio to gold and silver? Indeed, we are allocating a sizable portion (about 9%) of our total portfolio to these assets.

The remainder of this article will explain three key considerations for our positive outlook on gold and silver. And to make the discussion even more actionable and relevant to most investors, I will explain my thoughts based on the SPDR Gold Trust ETF ( GLD ) and iShares Silver Trust ETF ( SLV ). These considerations are:

1. In the near term, I see gold and silver as an effective hedge against current macroscopic risks such as inflation and geopolitical conflicts.
2. In the longer term, gold and silver are two unique asset classes that add a unique diversification to our portfolio.
3. And finally, I see the current condition provides an attractive opportunity to profit from a silver-gold trade. As you can see from the chart below, in the past year, SLV:GLD price ratio ("PR") went down by about 20% (when we traded gold for silver) and then went up by about 20% (when we did the opposite). And I see the current PR still attractive for this trade. More on this later.

GLD and SLV: basic information

There is a range of ways to invest in precious metals. However, for most ordinary investors like myself, obtaining exposure via popular ETFs such as GLD and SLV is not only the most convenient way but probably also the better way all around. For example, both GLD and SLV are backed by physical bars. And they charge 0.4% and 0.5% of management fees, respectively. For ordinary investors to hold physical gold and silver bars, the storage and insurance costs are usually much higher, let alone the difficulty of trading physical bars.

Thus, in the remainder of this article, I will explain my thoughts based on GLD and SLV in a way that makes their essential interchangeable with gold and silver. This is a good approximation, especially in terms of prices. GLD and SLV prices track the real prices closely given their low fee and liquidity.

1st consideration: Macroeconomics

For precious metals (or any other asset classes really), real interest rates act as the gravity of their valuation more than the nominal rates. Generally, when real interest rates go down, precious metal prices go up. And under the current combination of macroeconomic conditions, the current real interest rates are relatively low. As you can see from the following chart, the current 10-year real treasury rates are quoted at 1.19% from Ycharts, not that far from its long-term historical average of 0.84%.

Furthermore, my estimation of the current real interest rate (and also projected real rates going forward) is much lower than the Ycharts numbers. My estimate is that the real interest rates are in the negative region currently (with nominal rates in the 3~4% range and inflation hovering around ~6) and would remain close to zero in the near future (with both long-term treasury rates and inflation stabilizing around ~3%).

If you agree with my above estimates, then it is a no-brainer to consider gold and silver. They have historically provided an effective hedge against inflation and are currently underpriced in my view, as detailed next.

2nd Consideration: A unique asset class at a good price

Gold and silver have historically provided an effective hedge against inflation - and other risks too as a unique asset class. Gold and silver investors like to say that every other asset class you own is someone else's liability at the same time - except gold and silver.

Indeed, both gold and silver have demonstrated effective diversification power in the long term as you can see from the results in the table below. As seen, both GLD and SLV have displayed low or even negative correlations against all asset classes such as treasury bonds, stocks, REITs, and also cash. For example, GLD is correlated to the overall stock market with a coefficient of 0.07 (i.e., almost no correlation at all). And SLV's correlation coefficient to the stock market is slightly higher (0.27) but is still a very weak correlation.

Furthermore, both assets are currently for sale at a good price the way I see things. GLD's current price of $179 is near a 20-year peak as seen. However, its current price is the same as it was in 2012, about 10 years ago. The inflation since then has totaled ~30%. So GLD price has lagged inflation by about 30% in the past decade, while historically, the gold price has outpaced inflation by a good margin of more than 4% as you can see in the second chart below.

SLV price is similarly compressed as you can see from the bottom panel of the first chart. Its current price of $21.8 is about the same as it was in 2013. And as a result, SLV price has also lagged inflation by about 30% during this period, while the silver price has also outpaced inflation historically (by about 1.6% as seen in the second chart below).

3rd consideration: Silver-gold price ratio still attractive

As the name suggests, the silver-gold trade is a strategy to trade gold for silver when you think the silver price is more attractive, and vice versa. A simple metric to evaluate which one is more attractive is the gold-silver price ratio (PR, also known as the mint ratio). In the long term, the PR has fluctuated most of the time between a range of ~35 and ~95 as seen in the second chart. The long-term arithmetic mean is 58.8 since the 1970s. Currently, the PR sits around ~77.7, far above the historical mean (by about 32%), signaling an attractive time to trade some gold for silver.

The current PR is even more attractive judged by the geometric average. The geometric PR is ~57.6x, slightly below the arithmetic mean and thus making the current PR more attractive for silver. These are the considerations for our silver-gold as shown in the first chart. Our gold-silver trade has paid off nicely in the past few years as the PR oscillated in recent months. If you recall from the chart, we have been accumulating silver during the earlier part of 2022 when the PR peaked above 90%. And we gradually trimmed our silver allocation and bought back gold as the PR rose.

Risks and final thoughts

Investment gains in precious metals (GLD and SLV are no exception) are taxed at the maximum tax rate of 28% or 29.6% rates because they are considered collectible, substantially higher than the normal capital gain tax rates. Investments in ETFs such as GLD and SLV, instead of physical bars, also expose you to the so-called "counterparty risk". Ultimately, such "paper gold" or "paper silver" relies on the ability of another party to uphold their contractual obligations.

Finally, the expense ratios of SLV and GLD (0.5% and 0.4%, respectively) are reasonably low but still higher than some of their peers. That is the reason I use the Aberdeen Standard Physical Silver Shares ETF ( SIVR ) and the iShares Gold Trust ETF ( IAU ) in my portfolio as shown below. SIVR and IAU are smaller ETF funds compared to SLV and GLD. But their fees are only 0.3% and 0.25%, respectively. I do not actively trade, and SIVR and IAU already provide sufficient liquidity and narrow trading spread for me.

To conclude, I have an overall positive outlook on gold and silver given current conditions. My main considerations include the currently low (or possibly negative) real interest rates and their unique diversification power. Finally, their current PR provides an attractive opportunity for silver-gold trade. Actually, most of my current metal holding is in silver (7.2% out of the total 9.0% allocation as seen). I am monitoring the GLD-SLV PR closely and will write an update article when I see the need for allocation changes.

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