Since my earliest days of investing, I have heard arguments about the pros and cons of investing in commodities such as gold and silver. In recent weeks, those arguments have come to the forefront due to speculation about a third quantitative easing (QE3). Quantitative easing occurs when the Federal Reserve takes monetary actions to stimulate the economy by increasing the money supply. An increase in the money supply reduces the value of the dollar and pushes investors away from dollar based investments, and towards more stable hard assets like gold and silver.

On September 13th, the Federal Reserve chairman Ben Bernanke ended the speculation and announced that the Federal Reserve would initiate a QE3. The announcement was generally considered to be good news for gold and silver investors. In the days preceding the announcement, the tracking stocks for both gold and silver had been moving higher. The I Shares Gold Trust’s (NYSEArca:IAU) price moved higher by 4% and the I Shares Silver Trust’s (NYSEArca:SLV) price moved higher by 6%. The rise of these stock prices was predictable because in the past, the prices of gold and silver have spiked after QE’s.

Another trend that is encouraging for gold and silver investors is that the U. S. is not the only country that is in need of fiscal stimulus. For instance, several European countries, which are saddled with high unemployment, are printing money to pump up their economies. This decreases the value of their currencies and further increases the appeal of gold and silver. Considering the fragile state of the financial systems in Europe and the geopolitical concerns in the Middle East, don’t expect the gold rally to end any time soon.

While the short term future for gold and silver looks good, investors need to consider, how the price of these precious metals will trend over the long term. There are some analysts that think that the recent rise in precious metal prices has been driven more by technical matters than by supply and demand, which will ultimately determine their long term prices. In regards to the gold supply side of the equation the news has not been good. It has been estimated that over the last year, there has been only a 1% increase in gold discoveries. However on the demand side of the equation, there has been a marked increase in the demand for gold. In Europe, the Central Banks which used to sell gold, have become buyers. In 2010, the Central Banks bought 77 tonnes of gold, and in 2011 they increased their purchases to 440 tonnes. In the U. S. investors have increased their demands for gold, and India has also become a big buyer of gold. In regards to silver, the fundamentals are similar. The supply of silver has not significantly increased while the demand is trending higher. While gold and silver prices can be somewhat volatile a flat rate of supply and increasing demand, should keep the prices of gold and silver relatively high.

There are four ways to buy gold and silver. Investors can buy stock in precious metal mining companies, or buy shares of Exchange Traded Funds (ETF’s), or buy shares of precious metal streaming companies or buy actual gold or silver bullion. Of the four methods for buying precious metals, I would recommend investing through ETF’s or metal streaming companies. When an individual invest in mining companies they take on the companies operational risk, of which there are many. When an individual takes physical possession of gold or silver they lose the advantage of liquidity. The price movements of ETF’s and metal streaming companies are closely related to the price movements of gold and silver. The most popular gold and silver ETF’s are the iShares Gold Trust and the iShares Silver Trust. Metal streaming companies purchase gold or silver from mining companies for a predetermined price and without the need to outlay upfront capital.  As a result of doing business this way, the streaming companies have limited operational risk and their earnings relate closely to the market price of gold or silver. The largest gold streaming company is the Franco-Nevada Corporation (NYSE:FNV). The largest silver streaming company is the Silver Wheaton Corporation (NYSE:SLW).

The Risks

While it is likely that the central banks stimulus initiatives will give a short term boost to the price of precious metals, potential investors should not forget that gold and silver prices are volatile. There are several situations that tend to depress the prices of gold and silver.  It was mentioned earlier in this article that the price of precious metals rise when interest rates fall, conversely the price of these commodities falls when interest rates increase. The prices of gold and silver are also affected by the performance of the stock market. When the stock market rallies investors will often switch their investments away from commodities. A third factor that can depress the price of gold and silver is the supply and demand. The biggest stores of gold are held by central banks. While central banks have limits on how much gold they can buy and sell, it is generally accepted that when the banks buy gold, prices go up and when they sell gold, prices go down.  The price of silver (which is used for commercial purposes) is greatly affected by the performance of the global economy. The recent movements in the price of gold and silver are a good example of how volatile the price of these commodities can be. Gold is now selling for around $1,763 per ounce which is down about 9% from September 7, 2011 when it closed at a price of $1,923.74. Silver is now selling for around $34 per ounce which is down about 42% from April 28, 2011 when it closed at $48.53.

Conclusion

Gold and silver prices are on an upward spiral, and the prices of both are near their six month highs. In additional good news for gold and silver investors, the European Central banks are working to stimulate their economies and the Federal Reserve announced QE3 on September 13th. For these reasons, gold and silver prices should remain high for at least the next few months. Investing in the stock market is inherently risky, therefore prospective investors should do further research.