Sparkling Assets

So far, in 2024, silver has returned over 30 per cent, followed by gold, which has returned 23 per cent compared to 15 per cent for the equity benchmark Nifty.

 As investors, we are always seeking ways to optimise our portfolios for long-term success. So, it is natural to wonder about the role these precious metals can play in our investment strategies. We examined over two decades of gold and silver returns alongside the Nifty index to determine whether these assets deserve a place in a well-diversified, long-term portfolio.

 The key question we aim to answer is: Do gold and silver rate a place in a long-term equity portfolio? If yes, what is the optimal amount of gold and silver to hold for maximising returns while minimising volatility?

 By evaluating historical performance, volatility, and key influencing factors of these three assets, we explore the potential benefits of diversification and optimal asset allocation strategies.

 Our findings suggest that a portfolio primarily allocated to equities, supplemented by moderate gold exposure, can offer not only more stable risk-adjusted returns but also potentially higher absolute returns with reduced drawdowns compared to a Nifty/equities-only allocation strategy. Given its historical performance, silver only merits a small allocation in constructing a low-volatility portfolio.

 Proponents argue that these precious metals serve as a store of value, preserving purchasing power during times of economic uncertainty. They also point to the potential for portfolio diversification, as gold and silver often have low correlations with stocks and bonds. Supply constraints and growing demand can drive prices higher, and investors often seek these assets as safe havens during crises, boosting their prices and potentially leading to price appreciation.

 On the other hand, critics argue that gold and silver do not generate cash flows, which goes against the classical definition of an investment. Owning physical metals incurs storage and insurance costs, and their long-term returns have historically lagged behind stocks, raising questions about opportunity costs. Additionally, speculative interest and emotions can lead to ill-timed buying and selling decisions, and prices can be highly volatile, driven by shifting investor sentiment.

 While these theoretical arguments provide context, our analysis focuses on historical data to evaluate the potential benefits of including gold and silver in a long-term investment portfolio.

 To understand the long-term dynamics, we looked at the rolling three-year returns of the Nifty, gold, and silver from 2003 to the present. Over this period, the Nifty has been ahead 56 per cent of the time, with silver and gold leading 23 per cent and 21 per cent of the time, respectively.

 While the Nifty has shown the highest annualised return of 13.2 per cent over the past two decades, gold follows closely with an annualised return of 12.1 per cent and significantly lower drawdown and volatility. Silver, despite its recent surge, has been the worst long-term performer of the three, with an annualised return of 10.8 per cent, drawdowns comparable to the Nifty, and significantly higher volatility.

To illustrate historical performance, consider the following example. If you had invested Rs 100 in the Nifty three years ago, in October 2021, your investment would now be worth about Rs 141, a healthy 40 per cent cumulative return. However, an investment in silver over the same period would be worth Rs 153.8 per cent more than the Nifty, and gold would be worth Rs 159, a respectable 13 per cent more than the Nifty investment.

 In 25 years since 2000, the Nifty has led gold and silver in 12 years. Most notably, in 2014 and 2021, when both the metals delivered negative returns while the Nifty was up over 20 per cent. On the other hand, gold has led in times of distress for global equity markets, like in 2008, when it was up 25 per cent while the Nifty was down over 50 per cent. Silver, too, has had a resurgence lately, leading the Nifty in three of the last five years.

Given the Nifty’s historical outperformance, it is natural to wonder why not allocate 100 per cent to this index. After all, a 1 per cent incremental return compounded over two decades results in a portfolio nearly 20 per cent larger.

 The answer lies in the power of combining uncorrelated assets to improve risk-adjusted returns. For instance, during the global financial crisis of 2008, when the Nifty fell by over 50 per cent, gold proved to be a safe haven, rising by nearly 30 per cent in the same year. Historically, portfolios combining gold and silver with the Nifty have offered better risk-return profiles when maintained over the long term.

 Consider a simple 50:50 Nifty-gold portfolio, rebalanced annually. This strategy would have outperformed a 100 per cent allocation to either asset class over the long term while experiencing moderate drawdowns compared to a 100 per cent Nifty portfolio.

 Combining gold and silver helps improve the risk-adjusted returns of a long-term portfolio. But what is that ideal mix of the three?

We also took it a step further by analysing every possible asset combination from 0 to 100 per cent of each asset relative to the others. This meant analysing over 5,000 possible combinations. Each of those combinations plotted a return versus risk (volatility) chart.

 The results suggest that from 2000 to 2024, the highest return while minimising volatility would have come from holding 32 per cent gold and 68 per cent Nifty. This portfolio would have achieved an annualised return of 14.2 per cent with a volatility of 17.8 per cent. On the other hand, the lowest volatility combination while maximising returns would have been a gold-heavy portfolio with 62 per cent gold, 35 per cent Nifty, and a small 3 per cent silver allocation, resulting in an annualised return of 13.6 per cent and a volatility of 14.5 per cent.

While our analysis provides valuable insights, practical aspects must be considered when implementing such a strategy. Factors like transaction costs, taxes, and the uncertain nature of future performance can impact real-world returns.

Transaction costs and capital gains taxes from yearly rebalances would reduce but not eliminate the excess return of annually rebalanced strategies. The availability of gold ETFs in India since 2007 and silver ETFs since 2022 has made it easier for investors to gain exposure to these assets, but prior to this, implementing such a strategy would have required physically owning the metals, making rebalancing significantly harder.

 It is also crucial to recognise that optimal allocations depend on historical data and the chosen date range. For instance, beginning our analysis 10 years later, from 2010 to the present, yields the highest return combination as an even more Nifty-heavy portfolio with a lower allocation to gold. Future performance is inherently uncertain, and the prices of physical assets like gold and silver will be determined by supply and demand dynamics that are challenging to predict.

 Moreover, a multi-asset portfolio combining lower-return assets will inevitably lag equities over long periods, especially during bull markets. Investors who constantly compare their portfolio’s performance to the market may find it psychologically challenging to maintain such a strategy, as the optimal portfolios from our efficient frontier analysis trail the Nifty on three and five-year rolling returns nearly 60 per cent of the time.

 However, holding uncorrelated assets like gold and silver can provide a psychological boost during equity market downturns. As the saying goes, “put 10 per cent in gold and hope it does not work.” This diversification can help investors stay the course and avoid panic-selling during market turbulence, providing a behavioural advantage that can lead to better long-term outcomes.

 As investors, it is crucial to have a financial plan and behavioural discipline in place to weather the uncertainties of the future. By incorporating a judicious allocation to gold alongside equities, investors may find the resilience and peace of mind needed to stay invested for the long run. As Benjamin Graham wisely advised, “The best way to measure your investing success is not by whether you are beating the market but by whether you have put in place a financial plan and a behavioural discipline that are likely to get you where you want to go.”

In the end, the optimal portfolio allocation depends on an individual’s risk tolerance, investment horizon, and financial goals. Our analysis aims to provide a framework for considering the role of gold and silver in a long-term portfolio. Investors should consult with a financial advisor to develop a personalised investment strategy that aligns with their unique circumstances. By embracing diversification and maintaining a long-term perspective, investors can navigate the ups and downs of the market with greater confidence and ultimately achieve their financial objectives.

About The Author

Anoop Vijaykumar