The Best Long-Term Investment: Gold vs. Silver vs. S&P 500

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 |  Includes: AGOL, AGQ, DBS, DGL, DGP, DGZ, DZZ, GLD, GLL, IAU, IVV, PHYS, SGOL, SIVR, SLV, SPY, UBG, UGL, USV, VOO, ZSL
by: Sergei Barna

In recent years investors have witnessed a spectacular rise in silver and gold prices, while the S&P 500 stock index, having experienced two declines of 50% or more in the last decade, is still significantly below the levels it reached in 2000. It used to be that hoarding gold and silver was the purview of the die-hard gold bugs but it seems that today a lot of investors, big and small, prefer putting their money into precious metals, whether in the form of ETFs, such as GLD and SLV, or physical bullion. Obviously, if you bet big on anything when it starts a big move up, you can make a lot of money. But since most of us can't perfectly time the markets, I wanted to compare historical returns to three investment strategies where every year you consistently invest in either S&P 500, silver, or gold.

Suppose, starting in 1981 you were to invest $1000 each year in either S&P 500 index, silver, or gold at the average price for that year. For the S&P 500 strategy you would reinvest the following year the dividends received during the current year along with the next $1000 investment. Columns 1, 2 and 3 of the table show the value of your holdings at the average price for that year for S&P 500, silver, and gold, respectively. Columns 4, 5, and 6 show the annual compounded returns that your investments would have earned through that year.

(1) (2) (3) (4) (5) (6)
Value Value Value Comp. Ann. Comp. Ann. Comp. Ann.
SP500 ($) Silver ($) Gold ($) Ret. SP500 Ret. Silver Ret. Gold
1981 1,000 1,000 1,000 - - -
1982 1,987 1,755 1,819 -1.33% -24.47% -18.12%
1983 3,772 3,533 3,050 23.84% 16.83% 1.65%
1984 4,935 3,518 3,596 14.19% -8.51% -7.06%
1985 6,994 3,648 4,165 16.85% -15.83% -9.15%
1986 10,150 4,251 5,831 20.87% -14.02% -1.14%
1987 13,601 6,458 8,076 21.67% -2.70% 4.73%
1988 14,087 7,013 8,895 15.71% -3.80% 3.01%
1989 18,599 6,905 8,764 17.40% -6.80% -0.67%
1990 20,893 7,066 9,821 15.59% -8.02% -0.40%
1991 25,312 6,932 10,273 15.70% -9.77% -1.38%
1992 29,775 7,744 10,750 15.43% -8.42% -2.03%
1993 34,221 9,463 12,255 14.94% -5.51% -0.99%
1994 36,768 12,596 14,076 13.71% -1.65% 0.08%
1995 45,377 13,386 15,073 14.42% -1.65% 0.07%
1996 58,191 14,393 16,217 15.49% -1.43% 0.18%
1997 77,838 14,556 14,844 16.85% -1.98% -1.73%
1998 99,089 17,466 14,190 17.56% -0.36% -2.89%
1999 124,258 17,453 14,454 18.06% -0.95% -3.16%
2000 136,028 17,563 15,476 17.38% -1.39% -2.80%
2001 116,285 16,498 16,027 14.83% -2.50% -2.81%
2002 99,419 18,362 19,325 12.55% -1.77% -1.26%
2003 99,103 20,479 23,676 11.61% -1.07% 0.26%
2004 119,017 28,947 27,649 12.05% 1.59% 1.21%
2005 130,652 32,789 31,043 11.87% 2.18% 1.75%
2006 144,837 52,793 43,160 11.77% 5.22% 3.81%
2007 166,748 62,178 50,737 11.91% 5.84% 4.50%
2008 142,317 70,637 64,555 10.34% 6.19% 5.63%
2009 114,343 84,285 84,990 8.54% 6.79% 6.84%
2010 140,892 140,970 92,852 9.18% 9.18% 6.90%
28-Apr-11 173,400 233,917 115,889 10.28% 11.84% 8.12%
18-May-11 170,931 166,144 112,880 10.20% 10.05% 7.98%
Click to enlarge

Investing in stocks had been much more profitable in the first 20 years. In 2000 the average value of your stock holdings would have been $136,028, whereas silver and gold would have been worth $17,563 and $15,476, respectively. Furthermore, silver and gold investments would have had a negative or near zero compounded annual return until 2004. Since then however, the precious metals have begun to quickly make up ground and, helped by S&P 500's 57% crash during the last recession, silver managed to slightly surpass stocks in 2010, while gold was still behind. On April 28, 2011, when the price of silver was near its peak, silver was a clear winner with a value of $233,917 and a compounded annual return of 11.8% compared to S&P 500's $173,400 and 10.3%, and gold's $115,889 and 8.12%

However, the subsequent price decline put silver behind S&P 500. As of May 18 close, the stock portfolio would have been valued at $170,931; silver at $166,144; and gold at $112,880. At the current level of the S&P 500 index the break-even price for silver is $36.10 per troy oz, and for gold -- $2,290.77 per troy oz.

At this point, the attractiveness of each of the investment vehicles depends on your beliefs of where the prices will go from here. The S&P 500 has the higher historical annual rates of return on its side, but if you really think that recent rates of price increases for gold and silver will continue into the future, you would obviously prefer the metals. Personally, I believe investing in stocks is a better long-term strategy for the following reasons:

1) The magnitude of compounded rates of return depends a lot on the window of time you select. It would have been worse for gold and silver if I had started with 1979, and much better if I only took 2003 and later years. And all the years in between were terrible for gold and silver. I think that it's a lot more likely that at this point we are on the back side of the price hump for silver and gold.

2) One of the main reasons to hold PMs is hedging for inflation. But stocks are also an inflation hedge, since if inflation were to occur, the companies would be selling their products and measuring earnings in inflated dollars. And while the potential inflation seems to be more than priced in into silver and gold, stocks are most likely not priced with expectations of high inflation.

3) The transaction costs of buying and selling physical bullion are very high and eat into your profits. Also, if you own bullion, instead of ETFs, like SLV and GLD, you will have storage costs unless you are planning to hold all of your PMs in your house (in the above analysis you would have accumulated 4803 troy oz (or ~149 kilos) of silver. Holding S&P 500 in the form of an ETF, you would incur comparable management fees, so that cancels out, but looking at historical price charts, it is easy to forget about the dividends that you receive holding stocks. Over the 30 year period in my example, you would have accumulated and reinvested $39,921 in dividends.

4) And finally, the IRS will take out a much larger chunk of your capital gains in precious metals than it would of your long-term capital gains on stocks. Currently, it taxes gains on PMs at a maximum 28% rate, whereas the rate for both dividends and capital gains on stocks is 15%.

The data used in this analysis comes from LBMA's website for gold and silver prices, and Compustat for S&P 500 prices and dividends.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.