In addition to geopolitical issues, inflation and the resulting rise in interest rates continue to be the hot topics in the markets today. Although most commodities have seen price spikes in recent months, one particular component basket has been a rare loser over the past year: silver (see 12-month chart below, orange line).

Today I present a cautious and speculative argument for seeking exposure to silver within a diversified, multi-asset portfolio. My instrument of choice in this case is the esoteric ProShares Ultra Silver ETF (NYSEARCA: AGQ), a leveraged fund that targets twice daily movements in the price of precious metals.

What is the AGQ?

I looked at this ETF in more detail about 18 months ago. In a nutshell, AGQ “seeks a return that is twice the return of its underlying benchmark,” the Bloomberg Silver Subindex, for a single day. The fund trades on average more than one million shares per day, making the ETF highly liquid and narrow bid-ask spreads. Management fees are high at 95 basis points, but perhaps in line with a more complex and highly volatile instrument.

It is important to note that the ProShares Ultra Silver ETF has done a very good job of achieving its stated targets of 2x the daily movements in the price of silver. Even in the long run – which, to be very clear, is do not the objective of this leveraged fund – AGQ decently mimicked the performance of silver twice.

Since the fund’s inception in 2008, a 50/50 mix of AGQ and cash rebalanced monthly would have returned 3.6% per year. This figure is only about two percentage points lower than iShares Silver Trust ETF (SLV) returns, with the difference likely reflecting higher management fees, perhaps some lower volatility and a bit tracking error.

The Case of Possession of Money

Basically, it’s not too hard to justify owning money in today’s environment of currency devaluation and runaway inflation. Like gold, silver has always been treated as a store of value when investors fear a loss of purchasing power. But unlike its counterpart, silver benefits more from industrial applications: an estimated half of silver’s demand is associated with electronics manufacturing, from old-fashioned photography to renewable energy and automotive to more high increase.

Historically, silver prices have also benefited from a low real interest rate environment. The inverse relationship is visually evident in the graph below. Notice how, over the past ten years, silver has performed best when inflation-adjusted returns were low – although the negative correlation has weakened since the start of the pandemic. Real rates are still near all-time lows, although they have started to recover rapidly in recent weeks.

Despite the current landscape that most would argue should be bullish for silver, the precious metal has underperformed, as highlighted above in the introduction. I hypothesize that the uncertain macroeconomic environment introduced by the pandemic and its aftermath may have steered investors away from more speculative investments, which has hurt demand for silver – an asset that has produced annualized volatility very rich by 32% and painful peak drawdowns by 72% over the past two decades.

Perhaps now is the time to go long on the precious metal, especially if this is seen as an opportunity to buy weakness.

But why AGQ?

Seeking silver exposure through a regular fund, such as SLV, might make the most sense for many. However, I believe AGQ can play an important role in limiting a portfolio’s exposure to such a risky asset class, while providing investors with an upside opportunity in the short term.

Usually, I tend to rely on certain groups of stocks, inflation-linked bonds, gold and diversified commodities to seek protection against rising producer and consumer prices. Due to high volatility and lower than normal historical risk-adjusted returns, silver has never been part of my long-term diversified strategy.

But with AGQ I can add a very small speculative position to my portfolio (e.g. a few percentage points in allocation) without significantly selling what I consider to be better long term investments – e.g. stocks growth and other cash flow generating assets. If silver prices spike in the foreseeable future, my portfolio would benefit from the small position in AGQ. If it moves sideways or even declines, I can rest assured that my portfolio losses are limited to an amount I can be comfortable with.