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Precious Metal Investing: Silver or Gold?

Sam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For investors interested in precious metals, it really comes down to one decision: silver or gold? Although they frequently trade in tandem, and are often purchased for the same reasons, they are far from identical.

Each metal has its own trade-offs. I'll break down the relative arguments for owning one over the other, and then suggest ways for interested investors to get exposure.

The case for silver

Silver is often called the “poor man’s gold.” Trading near $1400 an ounce, it’s difficult for retail investors to buy much gold and still maintain a diversified portfolio. On the flip side, an ounce of silver can be had for $22 -- much more affordable.

But that affordable entry price carries some unfortunate side effects. Silver is notoriously more volatile than gold, meaning that it can be prone to wild swings.

However, for those who can take some short-term volatility, silver could be the better bet. Jeff Gundlach, the founder of DoubleLine -- one of the largest bond funds -- prefers silver over gold. In an interview with The Street’s Chris Ciaccia, he explained why.

Although Gundlach is not positive on silver (he thinks its price will go down), he believes it’s a better bet than gold.

According to Gundlach, if you're going to set aside say 5% of your portfolio for precious metals, you'd be better served to put that money in silver rather than gold. Precious metals are “dead money” -- they do not pay interest or offer growth.

That isn't to say that they are completely worthless investments -- they can be great inflation hedges. But if you're going to sink some of your investment capital in the metals, better to do it in the more volatile one. In the event that inflation really accelerates, silver should far outperform gold.

The case for gold

So should investors totally abandon gold for silver? Not necessarily. Besides silver’s aforementioned volatility, there are several ways in which gold is superior.

First, gold is a purer inflation hedge. While both metals have few industrial uses compared to say copper, gold has far fewer than silver. Meaning that the demand for silver -- and thus its price -- should fluctuate somewhat in-line with economic activity.

Secondly, silver is the poor man’s gold for a reason. While silver has often been used as a form of money in the past, it doesn't have gold’s rich tradition as having been the basis of most Western economic systems.

If you buy into some of the most extreme arguments that precious metals advocates put forward -- that all fiat money could one day implode -- then there is no substitute for real gold.

Many of the leading hedge fund managers that have increased their exposure to precious in recent years -- John Paulson, David Einhorn -- have bought gold, not silver.

Getting exposure to the precious metals

There are a number of ways to get exposure to the precious metals. Two of the more popular ways are through mining stocks and ETFs.

Of course, there’s another debate here. Some, like hedge fund manager Hugh Hendry, believe that buying stocks in the mining companies is literally insane. As the price of their product -- the mined metals -- rises, workers and governments are more likely to come after the companies.

And this has played out, to some extent. In recent months, shares of Gold Fields (NYSE: GFI) have slumped partially due to persistent labor strikes in South Africa, while Venezuela moved to nationalize its gold mines in 2011.

Investors interested in the miners, then, should take into account the location of their mines. Some geographical regions and political climates may offer higher degrees of safety than others.

Silver Wheaton (NYSE: SLW), one of the bigger silver-focused miners, has about half of its mines in North America -- Canada, the US and Mexico. On a relative basis, that might make it a safer bet than miners with a greater degree of exposure to economically troubled nations.

Yet, there are benefits to owning the miners. In the first quarter of 2013, it cost Silver Wheaton about $4.40 to produce an ounce of silver. If the silver price were to explode higher, the company’s earnings should likewise improve significantly, as its expenses should remain fairly stable.

Consequently, the miners are traditionally seen as leveraged plays on the underlying metal. Until it ran into problems with its workers, shares of Gold Fields rallied 100% from Oct. 2008 to Feb. 2011. At the same time, the underlying price of gold increased about 60% -- impressive, but obviously less than Gold Fields’ stock.

However, that leverage can work the other way, too. Shares of Gold Fields are down about 50% over the last six months -- gold itself is only down about 20%.

For those that want to avoid the potential headaches mining stocks can bring, ETFs can offer a more pure play.

The two major ones are the SPDR Gold Trust (NYSEMKT: GLD) and iShares Silver Trust (NYSEMKT: SLV). The former offers direct exposure to gold, the later silver.

Both funds largely work the same way. An amount of physical metal is stored somewhere, and investors can buy and sell claims to portions of that metal.

There are fees involved -- GLD's is 0.40%, SLV's is 0.50% -- but for someone who's looking for direct exposure to the metal without getting involved in the physical market, ETFs are likely the best bet.

And while the fees can lessen performance, the cumulative effects are not so severe. Since inception, SLV has appreciated 12.54%, while the spot silver price rallied 13.10%.

Precious metal investing

Precious metals might not be appropriate for every investor -- they certainly haven't performed well over the last two years or so. But they can play an important role in a balanced portfolio as a hedge against inflation.

For those that want to dedicate a larger portion of their portfolio to the metals, gold might be a better play -- it’s less volatile, and more of a pure hedge. Silver carries a higher risk/reward profile, so it might be better suited for investors that want to limit their metal exposure.

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