“The trend is your friend” goes an old market adage and in commodity markets this year, the precious metals have been a very good friend. Since the start of 2016, silver is the best performing futures market, moving higher by 42%. That compares to a 6.85% year-to-date gain in the S&P 500 index.

Often called a poor man’s gold, silver is a less expensive cousin to the yellow metal.

The going rate? An ounce of December Comex gold currently trades around $1,341 per ounce, compared to about $20 an ounce for December silver futures.

Dual Demand: Investment and Industrial
Silver can have an edge up on gold. Silver draws demand from both the investment arena as a precious metal, but also sees commercial demand for use in industrial applications.

A catalyst for demand for silver is expected to come from industrial sources in general and the solar industry in particular, says Sam Stovall, managing director at S&P Global Market Intelligence. “Silver is a major component in crystalline silicon photovoltaic cells. Even though oil prices are again moving lower, the demand for solar-generated power is increasing exponentially around the globe,” says Stovall.

Perhaps it’s this growing demand from solar that has helped silver outperform gold this year.

The Allure of Precious Metals

Physical Demand: One reason investors have been drawn to precious metals is the expectation of significant physical demand growth, driven in particular by consumers in China and India, Stovall says. Flight To Safety: “Recent developments, including Brexit and worries about the future of the European Union, have enhanced risks associated with geopolitical events, further supporting prices for precious metals known for their value-retention properties,” Stovall says. Negative Rates: As of late June 2016, there was an estimated $12 trillion worth of bonds with negative yields, which increased the appeal of gold as a flight-to-safety investment, Stovall adds.

Looking Beyond the Luster

Investors new to precious metals will want to do their homework before diving in, which is just good investing common sense when exploring any new investment opportunity. There are special factors surrounding the silver futures markets that traders need to understand, says JJ Kinahan, chief market strategist at TD Ameritrade.

“Trading activity in silver futures tends to be thinner than gold,” Kinahan says.

Average daily volume, or the number of contracts traded each day, has been rising for both gold and silver, but the yellow metal still reveals higher levels of liquidity. Through July, average daily volume in CME gold futures totaled 296,000 contracts versus Silver futures and an average daily volume of 74,000 contracts.

Thinner or less liquid markets can leave traders potentially vulnerable to large and volatile price moves. Kinahan pointed to an example: In September 2011, nearby silver futures marked out a monthly high at just over $43 an ounce, but fell to a low that same month at just over $26 an ounce.

Look before you leap. “If you are fairly new to trading or new to futures trading, this is probably not the springboard commodity. The liquidity can be tricky,” Kinahan says. “Everything is not for every trader,” Kinahan adds. More experienced traders could explore a pairs trading strategy using gold and silver, Kinahan says. Pairs trading allows investors to trade two correlated securities attempting to profit on a regression toward (or divergence from) their historical relationship. 

Get schooled: If you are new to futures trading check out this guide:  “An Introduction to Futures and Options” from the CME. 

Risks to the Rosy Outlook

Investment outlook: S&P Global sees consumer and investor demand rising significantly, due to higher market volatility and increasing geopolitical risk. 

However, S&P Global believes there are a number of potentially offsetting headwinds for precious metals, most notably a strong U.S. dollar and limited inflationary fears, Stovall says. 

“The relative strength of the U.S. economy and the U.S. dollar should restrain price appreciation from geopolitical uncertainty. Also, with the Fed expected to eventually resume raising interest rates later in 2016 or early 2017, precious metals become less attractive relative to interest-bearing securities since these metals pay no dividend and, when purchased with borrowed money, experience an increase in the cost of ownership,” Stovall concludes. 

Futures and futures options trading is speculative and is not suitable for all investors. Please read the Risk Disclosure for Futures and Options prior to trading futures products.

Investments in commodities are not suitable for all investors as they can be extremely volatile and can be significantly affected by world events, import controls, worldwide competition, government regulations, and economic conditions.

FIGURE 1: HI HO SILVER!

Silver futures are higher by about 42% year-to-date through early July. To track silver futures, log in to the thinkorswim® trading platform, click the Charts tab, and type “/SI” in the symbol box. Data source: CME. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.