How to invest in gold and silver

Introduction

Precious metals are some of the most important assets for traders, and considered a safe haven during times of market stress. Both gold and silver are quite similar in their market characteristics, but their price per weight is significantly different and their uses vary subtly. Gold is an inert precious metal that has been used as a display of wealth and store of value since prehistory. Gold jewellery remains one of the most important overall uses of the metal, with investment and the limited but important industrial applications filling out global demand. No other asset, especially not an easily storable and tradable one, has held value with the durability of gold. This makes it an attractive trading opportunity for CFD traders, who are able to share in the price action of this precious metal without taking delivery themselves. Silver has all of the same characteristics, but is more abundant and so cheaper, and is more widely used in industry. The price action of gold and silver is quite similar, but gold has more exaggerated safe haven characteristics. The easiest way to track the price differential is using the gold:silver ratio, which shows how many ounces of silver you need to buy one of gold.

Precious metals

First, some general background on precious metals. Precious metals are found inert and unmixed in a natural state, with gold and silver deposits forming pure seams in rock, or even being found washed up in riverbeds. This makes them easy to identify and work with, so precious metals are the first metals used by humans in prehistory. Because they are reflective and have an attractive colour, they are greatly in demand for jewellery, a characteristic exploited worldwide by many different peoples. Gold jewellery has immense cultural importance almost everywhere on the planet, but in terms of numbers, the Indian market is by far the largest today.

Precious metals naturally occur by themselves, as an unmixed element, though other forms are also possible. One of these is electrum, an alloy of gold and silver used in coins by the ancient Greeks. Today, surface deposits of gold are exploited extensively, with China and Australia the largest historical producers. Historically, South Africa has accounted for the majority of global production, with no country close to its 1960s peak. The largest silver producers are Mexico, China and Peru. Precious metals retain high values and have considerable demand, often driven by investors looking to hold onto a stable store of value, meaning new mining projects to bring in production sources are well-funded and regular.

Gold

Gold is the best-known precious metal, and most perfectly embodies the characteristics of the asset class. ADSS traders trade gold via CFDs, but elsewhere in the market people buy physical gold, gold futures, trade gold as an FX contract with the US dollar, or gain exposure through ETFs or even indirectly via mining stocks. Physical gold trading, also known as bullion trading after the eponymous standardised gold bars, is a popular method for investors who can provide secure storage. Some investors deposit their gold bullion in bank vaults or with a regulated bullion firm that protects customer deposits. CFD traders do not take ownership of the underlying asset, so do not have to concern themselves with storage, insurance, or the sale and handling of gold bars.

The other way physical gold is stored and traded is jewellery. Jewellery accounts for more than three quarters of annual gold use, with the remainder either stored by large financial institutions in bullion trading or used in industry. In terms of both household ownership and overall household gold holdings, India and then China are far ahead of all other nations, with the US a distant third, followed by Turkey. Gold jewellery is valuable because of the intrinsic worth of the metal and also due to the aesthetic pleasure it brings; well-designed jewellery sells for a price far beyond the value of the gold contained. Different purities and weights of gold make ‘gold jewellery’ a broad category containing very pure, fine gold down to mixed allows with a lower value per weight.

Gold purity can be measured in carats or with ‘fineness’,  with 995 (995 parts per thousand) the minimum for gold bars accepted by the London Bullion Market Association for Good Delivery. Good delivery is important because it is accepted worldwide as a regulatory standard for gold purity, with the fineness (often 995 or 999, sometimes higher), marked on the bar. Jewellery tends to use the familiar 24 carat system rather than fineness. 24 carats corresponds to 999 fineness, with Krugerrands and Sovereigns coming in at 22 carats or approximately 916 fineness. Below 12 carats (500 fineness), a given piece of gold is a 50/50 mix between elemental gold and whatever alloys it is mixed with, and lower ratings are mostly used in jewellery to improve durability.

Silver

Silver trades much like gold, but is significantly cheaper. The gold to silver ratio varies over time, with gold normally between 60 and 90 times the price of silver on a weight-to-weight basis. This can spike higher during times of market volatility, with ratios of over 100. Ratios below 30 are very rare, last seen briefly around 1980 and for a longer period in the 1960s, when the gold standard remained in force in many countries and gold prices were more tightly controlled by central banks. Most years, global mine production for silver is around ten times higher than for gold, so the lower price reflects supply concerns as well as perceived store of value.

As a pure element, silver is rarer than gold, but it is relatively abundant as part of an allow with other metals and easily extracted from them. Silver is used in jewellery, where its bright colour and softness, as well as reduced cost compared to gold or platinum, make it highly demanded. Additionally silver has extensive industrial and scientific applications, including as an antimicrobial agent; in solar energy, since silver makes the best mirrors; photography and in semiconductors.

Unlike gold, industrial applications count for around half of overall silver usage, which means there are competing elements in its price action: the overriding theme, as a safe haven and store of value, trading up during risk off environments and down in on, versus the industrial metal theme, which trades up during risk on periods of economic and industrial growth and down during flights to safety. Though the safe haven theme is dominant, silver does not have as strong a safe haven status as gold, and therefore the spikes in the gold silver ratio happen during times of market volatility.

Other metals: platinum and palladium

Precious metals normally means gold and silver, and these are the products traded by ADSS CFD traders. The spot price of gold and silver depends on various factors, but both are largely driven, in gold’s case almost entirely, by investors and the jewellery market. The remaining precious metals, platinum and palladium, are similar physically and in their rarity, but are much more important industrially than for investment or cosmetic purposes. This gives them different price characteristics, closer to industrial metals such as copper or iron.

Platinum is a metal with many characteristics in common with gold, but visually closer to silver. It does not corrode or rust, and is extremely rare, less common in the earth’s crust than gold. Platinum is commonly used in jewellery, often alongside diamonds, but its main uses are industrial, with important applications in catalytic converters, glass production, electrodes and medicine. Jewellery accounts for only around 25% of annual consumption, compared to 75% for gold. Though at points in history platinum has commanded higher prices than gold, it is absolutely not a safe haven asset, due to its links to industrial production. In 2008, platinum lost more than 50% of its per ounce value as stocks crashed.

Palladium is similar to platinum, and used alongside it in catalytic converters, which account for 50% of total palladium consumption. Palladium is relatively rare and the main deposits are concentrated in North America, South Africa and Russia. Historically, platinum has traded at a considerable premium compared to palladium, but this is not a fixed relationship and since 2008 has narrowed and at points slightly reversed. Because both metals have similar price drivers, they tend to be highly correlated assets.

Safe haven assets

Access to a simple and secure store of value means gold, including the trade in gold online, benefits from high trading volumes during market stress. This puts gold into the same category as the government bonds of developed markets, highly rated corporate debt, and reserve currencies such as the US dollar. Silver, highly correlated with gold, has a similar but less pronounced profile. Still, it’s important to make sure you have appropriate risk management tools in place as part of your trading strategy for such precious metals, because if the markets move against you, your capital could be at risk.

Trading precious metals

Precious metals can be traded in a few different ways, with ADSS traders using CFDs to share in their price action without taking delivery of the underlying asset. Even so, you still need to understand how other traders access precious metal markets, as this is one of the overall drivers of price action. The main methods for trading gold and silver are bullion trading, other physical methods including jewellery, spot trading as a forex pair, derivatives like forwards and futures, and contracts for difference. It is also possible to trade the shares of metals and mining companies, or indices based on these, with CFDs.

Gold and forex

Spot gold is often traded as a forex contract, with spot trades settled ‘on the spot’ at the prevailing market price, and settled within two days. Gold is almost always traded against the US dollar, but other gold / currency forex contracts exist. Because the gold market is highly liquid, the price action is comparable to major currencies, but there are a few key differences. When you trade gold as a forex pair, XAU / USD or otherwise, it is the firm that executes the trade who will (cash) settle the trade. This means you do not take delivery of the gold. In terms of payout profile and counterparty risk, trading gold as a forex pair is similar to using a precious metals CFD. Silver trading forex style is much less common, with reduced volumes and fewer market makers. CFDs provide an ideal option for sharing in silver’s price action.

Physical gold and silver

The simplest and oldest method to trade gold is to hold it physically in bars, known as bullion. Gold bullion trading is a major physical metals market, and retail investors sometimes use standardised gold coins such as Krugerrands to hold gold privately. The advantages of physical gold include zero counterparty risk, easy access to your holdings, and the aesthetic value of the object if held as jewellery. The downsides are obvious: storing a heavy, bulky metal and the high insurance premiums and security problems that ensue. Huge amounts of gold are held by national governments, central banks and major financial institutions, and storing large quantities of precious metals involves extensive security protocols to avoid robbery. This expense means physical gold is only appropriate for retail traders in smaller quantities.

CFDs

Gold and silver CFDs are an ideal way to access the market without taking delivery of the underlying product, allowing traders working on shorter timescales to enter and exit positions quickly. CFDs are less appropriate for hedgers such as gold miners looking to protect against falls in the price of the metal, despite the ease of going both long and short with CFDs, since they are better suited to intraday or short-term positions than the longer-term holdings required by hedgers. For retail day traders, CFDs are the most effective way to share in price action without taking physical delivery of the underlying asset. But just like other forms of trading, losses can exceed deposits, so ensure you are confident of your strategy before entering the market.

Forwards and futures

Forwards and futures are future-dated derivatives contracts that count for a large percentage of overall precious metals turnover, in common with other commodities and forex. Forwards differ from futures in that they are traded over the counter rather than on an exchange, and gold or silver forwards may be settled physically or in cash. Futures contracts such as COMEX gold are standardised forward contracts traded on an exchange; often they have high minimum sizes and are not suitable for the retail market.

Other asset classes: equities

When you trade gold you are trying to share in price increases in the overall gold market, often by using a derivative or indirect product such as a CFD. Equity investors sometimes use the indirect method of buying shares of gold mining companies, or indexes focusing on precious metals mining companies. Buying individual stocks also exposes you to company-specific risks, and few firms are exclusively focused on gold mining, so this approach is not perfectly precise. Even so, sustained increases in gold prices will result in improved profitability for gold mines, usually driving up share prices. Equities CFD traders can trade gold mining shares or indexes to share in these markets.

Price action of precious metals

How do precious metals normally trade? We have already identified a few points: gold and silver are highly correlated, they are correlated with other ‘risk off’ assets, they tend to be inversely correlated with the overall stock market, and they are both highly liquid assets. Out of all safe haven assets, precious metals offer the greatest opportunity for capital accumulation, since bonds have a fixed par value and currencies do not (normally) see massive appreciation in the long term.

Gold and silver trading strategies rely on the same technical and fundamental methods as other assets, with charting used to find entry and exit points and fundamental analysis providing the overall direction to trade. Remember to treat gold and silver differently: gold is the quintessential precious metal, and though silver is highly similar it also has some characteristics of an industrial metal. Understand the main uses of each metal, as well as the countries responsible for production; political uncertainty or natural disasters in those regions could lead to spikes in the price.

When trading precious metals, use the same risk management strategies as you would for a forex CFD trade. Gold and silver are not as risky assets as industrial commodities like copper or wheat, with fewer massive price collapses and no evidence of ‘supercycles’. Even so, remember these assets can both be volatile, and normal market correlations and relationships can break down under stress. When it comes to intraday trading, precious metals respond to the same technical factors as any other asset; look for support and resistance, and use momentum oscillators to estimate the strength of the prevailing trend.

Summary

Precious metals are an important asset class in their own right, sitting apart from other commodities. Like other commodities, supply from mines and consumption are major drivers of price, but unlike copper or nickel gold and silver are considered to have an intrinsic value and to act as a store of wealth, especially during times of market uncertainty. The cultural fascination and aesthetic interest in precious metals is as old as civilisation, and traders today are joining a long history of merchants, miners and speculators who sought to profit off bright metals. With ADSS, trading gold via CFDs gives you the flexibility of immediate market access, profiting off of price moves in gold or silver as they happen, without worrying about physical delivery. Precious metals traders use the same skills and analysis as equity or FX traders, but it is still important to be aware of the unique features and history of this major global market.

FAQs