A Comparison of Gold vs. Silver

Includes: CEF, GLD, SIVR, SLV
by: Old Trader

Let me start by saying that I don't consider myself a gold (or silver) bug. Having said that, however, as somewhat of a conservative investor, I do believe that precious metals do have a place in a well constructed and diversified portfolio.

It's certainly no secret that both metals, as well as their associated miners, have enjoyed a spectacular run-up (more so for silver), and both have also corrected, sharply in the case of silver, which is historically the more volatile of the two metals. There are at least a couple of questions facing investors at this point in time.

The first question would be, is this the start of a meaningful pullback, or just a sort of "pause that refreshes?" The second question would be, if one assumes only a correction, is it better to be long gold, silver or some combination of both?

Let me start by looking at the second question first. Although both are obviously precious metals, the drivers behind the demand are, I think, fairly different. Comparing gold and silver isn't comparing apples and oranges; it's more like comparing oranges and lemons. Both are "citrus," but their use is not especially interchangeable.

The primary uses of gold are as a store of value, as a "pseudo-currency", or as an investment. In point of fact, there's precious little practical difference between those three categories. There are some industrial uses, but any investor going long gold in anticipation of an explosion in industrial demand will likely be in for a rude awakening.

Obviously, governments and the central banks are the 800-pound gorillas in the room when it comes to demand for gold. Although what large "private" investors like Soros or Paulson may or may not do, might, in the short term, either fuel or dampen the ardor to own the "barbaric relic" among small, private investors, I don't feel that the activities of such market participants affect the longer term outlook for gold. Consequently, I feel that gold is essentially a pure "macro" play. If an investor concludes that we're not done with currency debasement, and global conditions will continue to be unsettled, to put it charitably, continued investment in gold makes complete sense.

The case for silver is a bit more murky. While there is, in fact, a history of silver being used as currency, and/or a store of value, I've not heard or read of any of the central banks acquiring any meaningful amounts of silver as a part of their reserves. Industrial demand plays a much larger role in pricing. I think it is important to realize that should current economic conditions continue, speaking in terms of currency debasement, the resultant slowing of economic activity will be a drag on industrial demand, which will tend to offset to some degree any increased demand for silver purely as a store of value.

Another factor that arises in any discussion of precious metals and the demand for them is the traditional use of precious metals for "savings/investment" in the emerging markets generally, and Asia specifically. This got me to thinking about just how much demand there might be from that quarter.

Going to the CIA World Fact Book, I found some interesting statistics. As of 2010, the most current figures available, here is the per capita income of various emerging countries, with a focus on Asia.

China: $4,300/yr.
India: $1,200/yr.
Philippines: $1,900/yr.
Indonesia: $2,900/yr.

It's well known that many Asian nations save at a much higher rate than Westerners do for a variety of reasons. The Chinese save roughly half of their income, and Indians save 25%. As a consequence of playing with these numbers, I think the case can be made, to some extent, that silver might have a somewhat greater allure, purely on the basis of price.

Ball-parking current prices, buying an ounce of gold would take more than a year's income for the average Indian, and almost half a year's income for the more wealthy Chinese. Keeping in mind that we're looking at average incomes, it seems to me that the poorest savers in emerging nations would find it more feasible to buy a few ounces of silver, as opposed to a single ounce of gold.

Of course, silver doesn't have the cachet accorded to gold, as evidenced by the proclivity of Indians, for example, to give gold jewelry as wedding and holiday gifts, for instance.

In summation, I believe that gold is the more macro play, suitable for those who wish to hedge against their exposure to the weaker global currencies, while silver is, in fact, more of a play on continued global expansion. As a guess, I'd say that silver's "worth" is 60/65% contingent on industrial demand, with the balance as a "store of wealth."

Investors would do well to look at such ETFs as GLD and SLV. For those skeptical of holding either, SIVR or the closed end fund CEF would be alternatives, or as I do, invest in some of the miners.

Disclosure: I am long GG, SVM.