Gold or silver: Which is better for your portfolio?

These precious metals are strongly correlated, but they serve different purposes. Here's what investors need to know.

By StreetAuthority Sep 13, 2013 9:02AM
Gold (© Comstock Images/Jupiterimages)By David Goodboy                                                                   

Gold and silver have always been and will always be many investors' favorite precious metals. The summer sell-off and subsequent bounce in gold and silver have reignited investment fever in the commodities.

Traders often substitute silver for gold because the two have a strong correlation with each other. However, the commodities are very different and should not be used interchangeably despite the seeming correlation.

Trading commodity futures is difficult. This is true even if you are on the inside. There is no such thing as illegal insider information in the commodity markets. Acting on information that would result in a lengthy prison sentence in the stock market is common -- and considered an edge -- in the commodity markets.

A company might have many millions in capital combined with near perfect information on supply, demand and supply chain logistics, and it might even own large stores of a commodity, but it is not guaranteed success in the volatile commodity futures market.
 
I have direct experience with this. Several years ago, our hedge fund advisory firm was fortunate enough to obtain capacity rights to a hedge fund that was the world's largest trader of a particular metal commodity. (Many top hedge funds are closed to new investments and permit only those firms with relationship-driven capacity rights to invest.)
This particular fund had an incredible track record -- it was up more than 100% during the year before our investment -- and was led by a trader who is widely thought to be among the best in that niche. My firm makes money only when our investors make money, so as soon as the capital was deployed, I was counting my small percentage of profits as virtually in the bank, based on the reputation and track record of this fund.

It employed sophisticated hedging and correlation strategies that supposedly locked in profits. These tactics, combined with the physical market knowledge, created a very compelling investment.

As fate would have it, soon after we invested, the fund inexplicably plunged in value -- the first time in the fund's history that it had lost money. What an incredible letdown!
 
However, this situation helped cement the fact that the past does not equal the future in the financial markets. In addition, I learned that there are many "old wives' tales" in the financial markets. One of these is that the big guys always make money. Even large funds, led by world-renowned experts, can and do lose money.


Secondly, commodities that appear to be correlated don't provide the same opportunities for investors. Specifically, correlation on a price chart doesn't necessarily mean one metal can be substituted for the other in an investment account. The primary reason is that each commodity is moved by different price drivers.

Price drivers are the underlying factors that affect the price of a financial instrument. Obviously, supply and demand are the primary price drivers of any stock or commodity. Price drivers break the economic theory of supply and demand into actionable parts.

The price drivers for gold and silver are very different. Gold is primarily used for jewelry and investment purposes. On the other hand, close to half of all demand for silver is from industrial sources. This means that demand for silver is tied more tightly than gold to industrial growth.

At the same time, gold demand is more closely tied to jewelry demand and macroeconomic factors like inflation and central bank actions. Unlike silver, gold is considered a store of value and is used by central banks on a grand scale for this purpose.

Supply is also very different. Both silver and gold are mined directly, but silver can be a by-product of gold refining and industrial processes.

This chart shows the ratio of the number of ounces of silver required to purchase 1 ounce of gold over the past decade.



Interestingly, there is more gold than silver aboveground. An estimated 5 billion ounces of gold have been mined, compared with 450 million ounces of silver. Despite the vast supply differences, gold is substantially more expensive than silver. Clearly, this isn't based on supply but rather demand. The perceptions of gold as an alternative currency and investment hedge push its value far beyond that of silver.

Risks to consider: As described earlier, precious metal investing can be extremely risky even for proven experts. This is particularly true for short-term trading. As in all investing, be certain to diversify.

Action to take: Despite the correlation, silver and gold are two different commodities with different underlying price drivers. Due to its lower price, silver can exhibit greater volatility than gold. Based on this, silver is a superior short-term trading vehicle, whereas gold makes more sense for the long term. A balanced portfolio will contain both gold and silver in a ratio best suited for the individual's goals.

As a longer-term trading vehicle, I like the SPDR Gold Trust ETF (GLD). Buying a breakdown to the 50-day simple moving average in the $128 range or a breakout above $135 makes solid technical sense right now.

David Goodboy does not personally hold positions in any securities mentioned in this article. 
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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12Comments
Sep 13, 2013 5:06PM
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I would not recommend the GLD  ETF with the current conditions that it cannot meet the requests for redemption by investors. Like the gold in Fort Knox (not able to return requests for stored gold by foreign governments). Something is going haywire in the precious metal industry. The market is being manipulated. The markets should stop trading in paper precious metals it is becoming Fiat paper like the us dollar, being printed and worth about the cost of the paper it is printed on from the Federal Reserve. The United States has allowed itself to go to crap. I look for the US fiat dollar to go bust and not be the Reserve Currency as it is today. Most of the governments in the world have figured this out too and have stopped buying the BS the US is selling, bonds etc. The Federal Reserve has the best method of stealing from the taxpayer and the world that has been devised. Like Rome the US is on the slippery slope of failure. As soon as China has enough Gold there may be a push for it to be in control like the US has been all of my life. If we do not get a good President and Congress to represent the people of the US like they should......God help us!!!

Sep 13, 2013 6:00PM
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Anyone else notice how these MSN Money ****s block anything that sheds light on their idiocy!
Sep 15, 2013 10:34AM
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Answer: Neither.Buy great stocks and sit back and enjoy the dividends.It`s worked for

me the last 20 years.

Sep 14, 2013 7:36AM
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Invest in geese that lay golden eggs, not the eggs themselves.
Sep 15, 2013 1:03AM
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Just remember Specie is not an investment.  It is a store of value.  It will hold it's value while paper money depreciates.  One should consider Specie as cash.   Specie is good if there is an economic collapse, it might be the ONLY money people will except. 

 

Never consider Specie as an investment... 

Sep 14, 2013 4:02PM
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For your own good, read Revalation. It gives future information you need to know before making judgements.

Sep 16, 2013 7:35AM
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I agree Gold/Silver can and are a store of value in some cases....

Also can be used for barter and trade..

A hedge against inflation and other issues.

 

To make money as far as investing...It has to be traded like any other instruments.

Some gold investments, such as miners; May pay a corporate dividend..??

Most profits in gold/silver are only in the appreciation of commodities themselves.

Most common investment advice, recommends at least a small percentage of a portfolio being invested in one or other.

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