Investor interest in gold is reaching multi-decade highs as the price of bullion is also attaining new highs. Many view gold as an effective diversification tool to offset inflation or weakening currency value concerns. However, it's usually best to purchase insurance when it's cheap. With that thought, we think gold's highly correlated but less prominent cousin, silver, may be a better investment today in relative terms.
While it's true that silver has been more volatile and has appreciated more in value than gold over the past year, it has not yet reached the pricing highs it attained just three years ago. Furthermore, it has lagged gold's price performance over the last two years. For investors willing to take the risks, we think that silver may be the better hedge of the two today.
For most investors, owning precious metals like silver makes sense as a hedge against the loss in purchasing power of paper currencies. Governments have historically been lousy stewards of the value of their currencies, and a precious metals position can help hedge a portfolio against such losses.
However, it should be noted that silver isn't a foolproof inflation hedge. Unlike gold, silver has industrial applications, which means it's more likely to fluctuate with economic ups and downs. If companies that use silver in their manufacturing process produce fewer products, silver prices are likely to suffer. More importantly, over the long haul, precious metals haven't returned much more than inflation. Historically, stocks have offered better protection against inflation.
Unlike equities or bonds, commodities are non-earning assets that are worth only what another party is willing to pay. However, commodities in general offer diversification benefits that can traditionally be reaped when other securities markets are performing poorly. Our research suggests that a 4%-10% total portfolio weighting for all direct commodities exposure is sufficient, and the majority of that weighting should be split among energy, agricultural, and industrial and precious metals.
Investing in silver isn't a priority for everyone, but it has some valuable uses. For one, it's a good hedge against inflation and the dollar, as the two tend to have an inverse relationship. That is, when the dollar gets weaker, precious metals are generally going up, because it's a limited commodity that retains purchasing power even when price inflation ratchets up. Conversely, when the dollar is strong, silver's value decreases because you may be able to get more bang out of the greenback than from the precious metal. And, because precious metals are generally uncorrelated to how stocks and bonds move, it can serve as a good diversification tool in your portfolio. Finally, unlike paper currencies, silver isn't at the mercy of government policy. Because it's not something that can be easily issued or mined, you won't see its value decrease overnight as you may if the government suddenly decides to pump up the circulation of currency in the market.
This is an edited version of Paul Justice's original article, which appeared on Morningstar.com and can be viewed here.
