In a perfect world, investors could eliminate all risk and make decisions with absolute certainty. However, this is not the world we live in. In fact, the increasing financial globalization of our world has arguably made investing a much more risky business as the increased interconnectedness of diverse markets has helped make these markets more volatile.

We all want high returns, but in unstable times (i.e. in the midst of the Eurozone crisis, slower growth in China, depressed oil prices) what we may be most concerned about is protecting our wealth. Although, gold and silver have often been considered safe stores of value, we find that many recent studies put this claim into question, and some suggest that other assets are much safer.

Key Takeaways

  • In tumultuous economic times, common wisdom suggests that precious metals like gold and silver provide safe havens from volatile markets.
  • As a hedge against inflation and more sound than central bank policy, investors have long sought out gold to ride out bear markets and recessions.
  • Academic research, however, that looks back at historical periods finds that gold and silver may not provide the safety people assume it has after all.

Safer Investing: Hedging and Safe Havens

Investors often use hedges and safe havens to limit their exposure to unwanted risks. A hedge can generally be defined as a security that is uncorrelated or negatively correlated with another asset on average, whereas a safe haven is an asset that is uncorrelated or negatively correlated with another asset in cases of extreme market stress or turmoil. In other words, hedging can limit one’s losses from holding certain riskier assets, while a safe haven allows one to limit one’s losses during times when most other assets are losing value.

Traditionally, precious metals like gold and silver have been considered effective hedges against inflation as well as safe havens during times of financial or political crisis. Unlike fiat currencies, the value of which can drop due to excessive government spending or loose monetary policy, the supply of gold and silver cannot be arbitrarily increased.

Further, currencies are only as strong as the government that issues and supports them. For this reason, political crises may cause investors to divest their holdings of the national currency and switch to gold or silver. Likewise, when other assets are losing value quickly in a financial crisis, many investors may turn to gold and silver, believing that these precious metals will insulate and protect their wealth.

Complicating Matters: Gold and Silver perhaps not the Safest of Treasures

Although both metals may be desired for their use as stores of value, unlike gold, silver is valued primarily for its industrial usage. These differences in demand fundamentals indicate that the two metals may react differently in different economic climates and should not be considered perfect substitutes.

One study finds that although gold price volatility is influenced by monetary factors, such as inflation or interest rates, silver is not and thus the two metals should be considered distinct assets.

Still, another study argues that although they act as safe havens during the same bond and equity market crashes, there are times when only gold acts as a relatively safe haven and other times when only silver does.

third study indicates that since silver’s demand is influenced more by its industrial usefulness, it will be much more closely correlated with general market activity. In other words, when economies are booming, there will be greater demand for silver than when economies are in a recessionary state. Thus, investing in silver when the market is heading for trouble may not be as safe as some analysts suggest.

Finally, when considering the volatility of the two metals, we find that gold is the safer asset since silver is the more volatile of the two. Yet, when considering other assets, gold is not necessarily the least volatile. Some suggest that Treasury bills actually perform better in this area, while another study found that the volatility index (VIX) was less volatile than gold during a sample period and thus acts as a better inflation hedge and safe haven.

The Bottom Line

Contrary to both tradition and popular opinion, gold and silver may not be the best hedges against inflation nor the safest of havens. In many ways, gold and silver are just like any other asset: their prices go up and their prices go down, and knowing which direction they will move in the future depends on a variety of factors.

Today, both the price of gold and the price of silver are at historic highs, and there’s no simple formula that will tell you which direction they'll go. It is far too simplistic to say that gold or silver will always protect one’s wealth from inflation or that they are always a safe bet when markets are heading south. There are other influences and variables affecting the performance of assets like gold and silver, and there may be other, much safe investments out there. The safest thing you can do is take your time and do your research.