Manipulation or Not, Is Silver a Smart Investment?

Silver has long been viewed as gold's stepsister. Not as pretty, not as profitable. But lately, silver's getting a second look. Shares of silver are up about 40% so far this year, compared to just over 20% for gold and beating other industrial metals as well as stocks and Treasuries.

Should silver be trading even higher? The silver markets have been under investigation for the past three years by the Commodity Futures Trading Commission because some analysts have suspected manipulation of the price of the metal, driving the price down. The accusation is that a few large traders control a majority of the "short" positions in silver futures. According to the CFTC, one third of the net short position in silver futures on the Comex, the New York metals exchange, was held by fewer than four traders.

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The Commission had been quiet about its findings, until Tuesday when Bart Chilton, Commissioner of the Commodity Futures Trading Commission, said in a hearing in Washington D.C., that there have been "fraudulent efforts to persuade and deviously control" the price of silver. The Commission is proposing new rules to prevent manipulation -- which should be a good thing for the silver markets.

New Rules Could Be Good for Silver

While the notion that these new rules could provide more upside potential for silver would be sheer speculation, investors should consider other reasons for why the markets are optimistic about silver.

"Silver could be the investment of the century," says Gregory Marshall, president and CEO of Global Asset Management, a wholesaler of silver, gold, platinum and palladium. One reason comes down to supply and demand. Silver is increasingly being used in hundreds of industrial applications and total demand in 2009 was more than 889 million ounces surpassing supply of 710 million ounces. Another reason: Silver, which is increasingly known as the "green metal" is being used more in water and air purification, as well as the fast growing market for solar energy cells.

Silver also appeals to the average consumer. Smaller investors who don't have enough money to purchase a significant amount of gold, often turn to silver instead. Understandable given that gold now sell for $1,400 an ounce while silver sells for $24 an ounce.

Silver Hits New Highs, But There are Risks

While silver is hitting new highs -- silver prices recently hit $22 an ounce and nearly touched $25 an ounce, its highest level since 1980 -- investors would be smart to understand the risks.

"Silver tends to be more volatile and may move more with economic activity because of its industrial uses," cautions Mike Savage, founder of Savage Financial Group. Also, for those hoping that investments in silver will continue to outshine gold, they should realize that the market for gold is much bigger than for silver. For silver to really prosper, an economic recovery could be critical since that would spur demand. But if the economy sputters, as many fear it will, the poor man's gold, may lose some of its luster.

A Good Addition to Your Portfolio?

If you plan to add silver to your portfolio, one way is to invest in a silver ETF such as ETFS Physical Silver Shares (SIVR) or iShares Silver Trust (SLV). Or you could invest in an ETF comprised of silver mining companies such as Global X Silver Miners ETF (SIL). But while silver has done well so far this year, don't expect that an investment now will lead to quick profits. Investors should have a long time horizon.

Be aware too, that like gold ETFs, silver ETFs, if held in a taxable account are viewed by the Internal Revenue Service as collectibles -- meaning you don't get long term capital gains rates if you hold the investment for longer than a year. You'll be taxed at the collectibles rate, currently 28%.

Finally, pay attention to the investigation into manipulation of the silver markets. Any fallout from the Commission's recent findings could put a damper on silver's price.