Silver vs. Gold Investing

Facts, figures, pros and cons for choosing or adding silver to gold...

 

SILVER INVESTING is often seen as merely an offshoot of the gold market, writes Adrian Ash at BullionVault.

 

If you like gold's trajectory, or so the theory runs, you've got to love silver. The cheaper metal has no life of its own, simply tracking the direction of gold prices.

 

History says that's true to some extent. But as this price chart shows, silver has twice outpaced gold many times over, first during the 1970s and then again in this early 21st century bull market.

 

 

With silver moving less quickly in 2014 so far, but with faster swings in between, this month also brings a new process for the world's daily benchmark price – replacing the 117-year old London Silver Fixing. Silver is therefore making headlines of its own, and many people investing in gold today wonder whether they should include silver, switch into the cheaper metal, or leave it out of the holdings entirely.

 

BullionVault can't advise you on which metal will prove a better investment long term. If we knew, we wouldn't offer or invest in both ourselves. But the notes below, we hope, should help inform your own research and choice in weighing up silver versus gold investing.

 

Correlation

No other tradable asset prices move as closely with each other as silver and gold. They've moved in opposite directions on fewer than 25% of all trading days since 1968, and only once split direction 7 days running. The average 1-month rolling correlation – a measure of how closely two things move together – is 0.63, a "statistically significant" link.

 

Volatility

Being much smaller than the gold market (one-tenth the size in London's wholesale dealing, and one-fifth the size in Comex futures), silver moves much faster when money comes in or out. For every 1% move in gold – up or down – silver moves 3% on average. That's why some London dealers call it "the devil's metal". Silver prices can move very fast – up or down – and hit short-term traders very hard, especially if they're using derivatives (futures, options, spreadbetting) to get leverage. Still, silver's extra spice, relative both to gold investing and mainstream asset price moves, has drawn a lot of "hot money" traders already in 2014. That trend looks set to continue as hedge funds and other speculators seek a fast return.

 

Physical use

Unlike gold, physical silver is primarily an industrial metal today. Indeed, US industry and lobby group the Silver Institute calls it "the indispensable metal", but that makes it vulnerable to the economic cycle. Silver use is rising worldwide, with demand growing by one fifth over the last decade. Investing played a big part in that. But the metal's greatest use for modern society comes from industry, and most especially because it is the most conductive element to heat and electricity. New and exciting uses continue to be developed, but as a key input into many fast-growing technologies, silver is also subject to "thrifting", where manufacturers work to reduce the amount of silver needed per unit. This has happened most dramatically in photo-voltaics, where the quantity of silver used to gather and conduct electrical energy in a solar panel has been reduced by up to 80% in some applications since the big price spike of 2011. Demand-led price rises, in short, can prove their own cure.

 

Gold/silver ratio

Some people trading precious metals today like to follow the gold/silver ratio. This simply measures how many ounces of silver you could buy with one ounce of gold. So at a silver price of $20 and gold $1300, the ratio would stand at 65. Historically, the ratio has gone from as low as 12 in medieval Europe, to 15.5 times during Great Britain's 18th century Sterling standard, and then as high as 100 during WWII and then the late 1980s as this chart of the Gold/Silver Ratio shows:

 

Trading between gold and silver, some BullionVault users – as well as other investors – hope to grow their long-term holdings of precious metals. They sell what they think the gold/silver ratio says is expensive, and buy the other metal, before switching back as the ratio changes. This can of course prove risky in cash terms, because even if you get the ratio trade right, you would lose monetary value if both metals fell in price.

 

Gold vs. silver trading costs

There are also dealing costs to consider. Swapping between physical gold and silver investment on BullionVault is cheaper than any comparable service we know. But you'll still incur two dealing fees of 0.5% maximum each side, plus the dealing spread (between buying and selling prices) if you accept the current best price to transact quickly. Alternatively, there's price risk inbetween completing both sides of the trade if you set your own quote, and wait for another user to accept your price.

 

Because physical silver is so much larger than gold for the same dollar-value, storage fees for silver are also higher. (See Bullionvault's full tariff here.) North American and especially European investors must also consider sales tax. Because unlike gold, silver is deemed an industrial metal for VAT purposes. So small bars and silver coins bought for your personal possession add 20% to the cost of silver investing in the UK, for instance – a tax you can escape buying Good Delivery metal inside secure, specialist London vaults using BullionVault. But choose to take that metal into your possession, and you'll trigger that 20% tax as well as losing direct access to the deep liquidity of the professional wholesale market.

 

End of the Silver Fix

It's unclear how the end of the London Silver Fix, and the start of the new daily London Silver Price, may affect pricing from mid-August. Most likely there will be no impact on the underlying trend, but this midday event does represent the deepest single moment of liquidity in the trading day. So acceptance (or rejection) by the largest buyers and sellers (think industrial users and miners) should be reflected in how the new output prices stand relative to other "spot" and futures contracts prices.

 

The current process has been used for almost 120 years. That proves its value, we think, rather than automatically qualifying it for the scrapheap. However, a separate administrator, plus auditable order trails from the major participants, should reassure regulators and key users of the London market that the new process is transparent and reliable. If so, it may reduce volatility around the midday event. But another theory says that, with traders scared to share information or deal at the Fix anyway, the current "scandal" has reduced daily movement in prices. So fresh confidence, and trading volumes, might help volatility in silver prices recover further from their recent pre-financial crisis lows.

 

Also note that the Gold Fix is likely going the same way, with the member banks of that process inviting proposals similar to the new CME/Reuters joint bid which succeeded in replacing the Silver Fix.

 

Bottom line?

Most common of the noble metals, resistant to corrosion and oxidation, silver also has the highest electrical and thermal conductivity of any element. So where it has been used to store wealth for 5,000 years, and was the foundation of most coined money systems before the mid-19th century, silver today finds 65% of its end-user demand from productive applications. That's why the depressionary collapse of late 2008 saw Dollar prices fall nearly 60%, whilst gold fell only 30% before turning sharply higher as the ultimate – and comparatively "useless" to industry – store of value.

 

But silver had already risen 5 times over during the half-decade before the financial crisis began, and it then shot another 5 times higher again to peak in spring 2011 near $50 per ounce – the all-time high hit in 1980 when Texan oil barons the Hunt brothers famously tried to corner the market, hoarding silver as a hedge against the strong inflation then destroying bond and stock investments.

 

Today's long-term silver investors seem happy to build their positions, awaiting a similar surge sometime in the future. It might arrive sooner than later if hot-money action in the derivatives market keeps growing like it has in 2014 so far.