Given all the uncertainty in the global economy - debt issues, easing programs, unemployment, etc. - many investors have taken comfort in owning precious metals. Designed to protect against inflation and ambiguity in the markets, the asset class contains much appeal. As such, gold, silver and even platinum and palladium have now become portfolio staples. While there is much debate over whether or not, investors should even own precious metals at all, there is a much bigger debate a-brewing. Just how should they get that exposure?

The exchange traded fund (ETF) boom has allowed investors to get their metals fix via a variety of funds that either track futures contracts - like the PowerShares DB Silver (NYSEARCA:DBS) - or own physical bullion like SPDR Gold Shares (NYSEARCA:GLD). Yet, there is strong vocal camp that believe that owning the physical metal, in a safe or bank vault, is the only way to go. For those investors wanting to tap the silver market, choosing between the two methods isn’t quite so simple.

Say Yes to the Funds
Funds like the iShares Silver Trust (NYSE:SLV) have made it quite easy for regular retail investors to tap the silver market. However, there are plenty of pros and cons that go along with that decision, rather than buying physical silver bullion.

Unlike gold, which is seen strictly as a store of value, silver also benefits from its wide use in many industrial applications. The metal has established uses in the automotive sector, across various electronics products, in solar panels and in photography. New technologies such as silver oxide batteries, silver conductive inks and various silver based nanotechnologies in medical applications are all quickly becoming standards in their industries.

This industrial demand makes silver prices “jumpier” than gold and generally react to various measures of manufacturing data. Given this fact, ETFs that track silver prices or futures could be a better bet versus physical bullion, as they can be sold quite easily if investors think prices are too frothy.

Then there are costs to consider. Buying physical bullion, of any precious metal, comes with added costs investors may not be thinking of. First, investor’s more than often pay 10 to 20% in commissions to acquire silver coins and bullion, depending on the source. For example, The United States Mint produces several silver bullion coins, with the most popular being the one-ounce American Eagle. At a recent price of $62.95 for an uncirculated condition piece, these coins sell at stiff premium to spot silver prices. Likewise, other coinage mints such as The Royal Canadian Mint also produce several silver bullion coins. However, these coins carry a similar premium when purchased directly from the Mint. Third-party vendors also exist, but again, premiums to spot are prevalent.

Then there are the storage costs to consider. Safety deposit boxes and banks can average $40 or more per month and home safes can range into the thousands, depending on the size, while precious metals IRAs and custodial accounts come with yearly storage fees as well. For the cost of just one share that trades roughly at spot prices, and as little as 0.50% in yearly expenses, investors can access silver via an ETF.

Don’t Count out Physical Bullion
That said, investors shouldn’t be so quick to just ignore the benefits of owning physical silver bullion. Perhaps the biggest is the counterparty risk associated with owning one of the ETFs or perhaps even more for investors owning an exchange traded note (ETNs) like the UBS E-TRACS CMCI Silver TR ETN (NYSEARCA:USV).
Shareholders don't actually own title to the metal itself, unless they are an authorized participant, if they go with an ETF. On the other hand, when you own actual silver it’s yours. If the world goes “crazy,” you have the store of vault directly in your own hands or vault. This fact underscores the number one reason why most investors choose precious metals in the first place: insurance.

A perfect example of the potential problems with counterparty risk stems from the recent bankruptcy at MF Global in late 2011. Investors who held warehouse receipts for silver bars within the firm’s accounts had their assets frozen and pooled together. The liquidating trustee in the court approved bankruptcy paid these investors about 72 cents on the dollar for their holdings. In other words, these investors lost 28% of their bullion. With some silver participants claiming manipulation in the silver markets with regards to many of the big ETF/ETN sponsors, owning physical bullion could pay-off in the real end.

Finally, the ETF’s fees do have an eroding effect on their underlying prices. Many of the physically-backed funds sell a portion of their bullion to pay for their expenses. Overtime, this has caused share prices to track less than spot. By the end of 2011, the popular iShares Silver Trust corresponded to 3.6% less silver since its launch in 2006 as fees have eroded the amount of bullion it has.

The Bottom Line
For investors looking to gain access to the silver markets, both owning physical bullion as well as purchasing ETFs have their pros and cons. Basically, it comes down to what they are looking for. If an investor seeks an easy and instant investment of silver, the funds come up shining. However, if a person truly believes that the financial system will collapse, physical silver is ideal alternative. Maybe owning both would be the most prudent move.

Related Articles
  1. Fundamental Analysis

    A Silver Primer

    Find out what affects the price of silver, the types of investments that can be made and the methods in which it is traded.
  2. Options & Futures

    Options On Gold And Silver ETFs

    Trading the commodities can mean extra expenses. These commodity-based ETFs give you the flexibility of trading like stocks.
  3. Options & Futures

    Trading Gold And Silver Futures Contracts

    If you are a hedger or a speculator, gold and silver futures contracts offer a world of profit-making opportunities.
  4. Options & Futures

    Trading The Gold-Silver Ratio

    This method may seem arcane, but many well-established strategies rely on it.
  5. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  6. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  7. Taxes

    Here's How to Deduct Your Stock Losses From Your Tax Bill

    Learn the proper procedure for deducting stock investing losses, and get some tips on how to strategically take losses to lower your income tax bill.
  8. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  9. Mutual Funds & ETFs

    Top 4 Global Real Estate Mutual Funds

    Read about four of the best global real estate mutual funds, which invest in the securities of real estate companies or real estate investment trusts (REITs).
  10. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  1. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  3. What are the main kinds of annuities?

    There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>
  4. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  5. How do I get out of my annuity and transfer to a new one?

    If you decide your current annuity is not for you, there is nothing stopping you from transferring your investment to a new ... Read Full Answer >>
  6. How often do mutual funds pay capital gains?

    The frequency with which mutual funds pay capital gains varies. However, funds that generate a profit within a given year ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!