During economic downturns or when a downturn is expected, 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 ongoing debate: Just how should they get that exposure?
The exchange traded fund (ETF) boom has allowed investors to get access to metals via a variety of funds that either track futures contracts, like the Invesco DB Silver Fund (DBS) or track physical bullion, like the SPDR Gold Shares Fund (GLD). Yet, there is a strong vocal camp that believes 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 (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 more volatile than gold and generally reactive 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, investors pay an average of 5% to 6% 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. These coins sell at a 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 at banks carry an annual fee 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 at roughly 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 Total Return ETN (USV).
Shareholders don't actually own title to the metal itself unless they are an authorized participant in an ETF. On the other hand, when you own actual silver it’s yours. If the world goes “crazy,” you have the store of value 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 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, ETF 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. Over time, this has caused share prices to track less than spot.
The Bottom Line
For investors looking to gain access to the silver markets, owning both 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 an ideal alternative. Maybe owning both would be the most prudent move.