Silver Investing for Beginners

Commodities investing poses special challenges that can save you or sink you, depending on how well you prepare before deploying capital.

Doug Ehrman
Doug Ehrman
Jun 9, 2013 at 8:03AM
Energy, Materials, and Utilities

Silver investing for beginners can be an overwhelming prospect when you consider the relative volatility involved in the silver market. Generally, there are three investment options to be considered, with only two that are potentially appropriate for novices: investing in the futures market, investing in the ETF market, or investing in silver companies. While many consider the purchase of physical silver a fourth option, unless you have significant capital to deploy, the commissions and premiums you will pay make this more doomsday preparation than pure investment strategy.

Let's examine each of the three options, their relative strengths and weaknesses, and a recommendation as to how silver might fit into your portfolio.

Silver futures: Silver investing for beginners will not include an investment in silver futures in most cases. The amount of capital needed to take any position in silver futures is generally more than most investors have for this allocation. One futures contract controls 5,000 ounces of silver, while a mini-contract covers 1,000 ounces. With silver trading above $20 per ounce, even the mini-contract represents a position of more than $20,000. Furthermore, questions of leverage, expiration, and margin are complications best avoided by less experienced individuals.

Silver ETFs: While there are several ETFs that track the performance of the silver commodity, the iShares Silver Trust (NYSEMKT:SLV) is the largest and most liquid. The advantage of investing in SLV is that you get the same performance that's available from the futures market at much smaller denominations. The forces that drive the commodity markets are different from those that drive stocks, meaning that silver companies are often at the mercy of both sets of drivers. Investing for beginners is often best kept as simple as possible, and ETF investments tend to be very straightforward. For these reasons, an allocation to SLV is a great way to get started.

Silver stocks: Silver investing for beginners can include the stocks of silver companies. The Global X Silver Miners (NYSEMKT:SIL) gives you exposure to a basket of silver companies and is a great way to get diversification, but it makes it very hard to control for company-specific risks. SIL's 10 largest positions account for about 74% of its holdings and include a diverse group of silver companies. So you get exposure to many companies, but it's impossible to avoid any that are facing specific issues.

In terms of individual companies, there are several good choices, but these can behave very differently. Pan American Silver (NASDAQ:PAAS), for example, missed revenue expectations and beat earnings expectations in its last earnings release. But despite the beat, EPS shrank considerably from a year earlier on a GAAP basis. The stock has been fairly flat ever since. Conversely, First Majestic (NYSE:AG) reported strong revenue growth and a small bump in profits, sending the stock higher since the announcement. First Majestic reported increased cash costs and tightening margins, largely driven by lower silver prices. Each of these companies faces pressure from increasing production costs and environmental concerns.

PAAS Chart

PAAS data by YCharts

One company that should be included in silver investing for beginners is Silver Wheaton (NYSE:SLW). Unlike the previously mentioned miners, Silver Wheaton is a silver streaming company. it buys the production of other miners at a set, pre-determined price, so it's largely insulated from many of the risks that silver miners must address. As a result of its existing contracts, Silver Wheaton currently claims the largest reserve of silver in the world, at more than 1 billion ounces. The company is able to maintain an operating margin in excess of 70% and has strong longer-term prospects for those taking a multiyear view.

Ultimately, while the methods I've discussed here all have their strengths, Silver Wheaton is a great blend of options for silver investing and makes a great choice for those who are just getting started in this area.

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