ETFs With a Silver Lining

As you put up silver bells on your tree and polish your special silverware, you might not think of those things as investments. Yet silver has given investors some spectacular returns in recent years. Now, there are two exchange-traded funds that let you buy in to the silver craze.

Two ways to play
Both of these ETFs are relatively new. The iShares Silver Trust (AMEX: SLV  ) is the older of the funds and is also the largest, with assets of just a little above $2 billion. The ETF holds about 145.4 million ounces of physical silver bullion. Its cumulative return since its inception in April 2006 is 16.65%.

The second fund, PowerShares DB Silver Fund (AMEX: DBS  ) , doesn't hold silver bullion. Instead, it uses a series of futures contracts based on an index developed by Deutsche Bank that intends to track the performance of spot silver. Using futures avoids the expense of holding actual metal. The fund collateralizes its futures contracts, primarily with U.S. T-Bills, which earn interest and thereby add to the total return of the fund. The fund has earned a 12.25% return since its inception in January 2007 and has only about $23 million in assets.

Both silver funds charge expenses of 0.50%. Even though they're both ETFs, neither one qualifies as a mutual fund or investment company within the meaning of the Investment Company Act of 1940, which affects the way they are taxed and regulated.

Why silver?
Since 2003, when it traded at less than $5 an ounce, silver has marched steadily higher, until it tripled in value by late 2007. Silver has the highest electrical conductivity for a metal, and because it has antimicrobial benefits, it is now weaved into some clothing. Demand for silver comes from a number of sources, including its use in jewelry, silverware, coins, and photography, along with industrial uses such as the electrical contacts used in computer keyboards. Silver is produced as a by-product of gold, copper, lead, and zinc mining.

With high oil and food prices underpinning a potential rise in inflation and a falling dollar increasing the prices of imported goods, silver might benefit as a storehouse of value. The turmoil and fear from the credit markets may also add support to high silver prices.

Diversification play
Silver is a commodity and subject to wide swings in price, so it's a risky investment. For most people, it should make up only a very small portion of their portfolio. Moreover, since silver is used in industrial applications, demand for the metal could slow in an economic decline. Just as speculators have helped drive silver prices up, it's possible that a reversal in their mindset could bring prices down quickly.

Silver is the lesser known precious metal, with gold getting most of the news coverage and headlines. But that doesn't mean you should ignore it. Because silver does not march in lockstep with the stock market, an investment in this precious metal can provide some good diversification for investors.

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