Gold and Silver – Birds of a Feather?

Dec 12, 2009 by

When we think of gold and silver, we often consider them to be very similar. Sure, gold is more valuable than silver. But, they are both precious metals suitable for jewelry and investing. When people get scared that their currency is going to weaken (become rapidly able to buy less), they tend to buy precious metals as a way to maintain the value of their wealth. If gold is simply a more valuable version of silver, then there should be no need to diversify between the two. On December 11th, 2009, gold cost $1,115.10 per ounce, and silver cost $17.13 per ounce. Is investing $10,000 in gold (buying 8.97 ounces) really financially equivalent to investing $10,000 in silver (buying 583.77 ounces)?

Perhaps suprisingly, changes in the prices of gold and silver are not that tightly correlated. The price of anything is determined by a combination of supply and demand. The size of the supply of gold and silver is determined by mining operations. As gold and silver are mined separately, the discovery of ore of one type does not influence the price of the other. Secondly, the nature of the demand for gold and silver differs. In addition to being used as a store of wealth, both are used for a myriad of industrial uses. Gold is particularly inert, which makes it invaluable for many applications. So, while the inflation and deflation of currencies may influence demand, there are many other factors driving demand as well. These other sources of demand likely drive the difference in performance between the metals.

Exactly how different is their performance? Examine these trailing performance statistics for December 11th, 2009:

Period Gold Silver
1 day -1.25% -1.25%
5 day -2% -5%
1 month 0% -2%
3 month 10% 2.50%
6 month 17% 12%
1 year 35% 65%
2 year 40% 20%

Note: These statistics are rounded, and are meant for illustrative purposes only.

So, what should an investor do? The answer is to diversify into both. If you are investing in gold and silver to protect yourself from currency risks, you might want to buy a bit of both to protect yourself from risk due to other shocks in their supply and demand.

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