How to Trade Gold, Silver and Other Precious Metals

When inflation concerns arise and geopolitical uncertainties dominate headlines, many traders turn to precious metals to add some “shine” to their portfolios (see what I did there?).

Here’s a comprehensive guide that goes beyond the usual “gold is an inflation hedge” narrative that you hear everywhere. Instead, I’ll focus on looking at the various markets from a quantitative perspective and examining systematic approaches to trading them.

This article is intended as a stepping off point for your own research and presents some ideas to get you started. None of these ideas should be considered fully formed trading strategies.

Let’s dig in.

Complicated Dynamics

Before we get into the mechanics of trading precious metals, let’s address the elephant in the room: gold’s price dynamics are, to use a technical term, complicated.

Here’s what makes gold fascinating and frustrating:

1. Scarcity Paradox
There isn’t much gold in the world – all gold ever mined would fit in a cube roughly 22 meters on each side. It would fit comfortably within a baseball field. Yet despite this scarcity, almost all gold ever discovered still exists, and we keep mining more (albeit at a slow rate).

2. The 6,000-Year Collective Delusion
For at least six millennia, humans have coveted gold. It’s shiny, doesn’t corrode, and has permanence that makes it ideal for coinage and jewelry. But here’s the thing: gold primarily has value because people believe it has value. Its industrial usage is relatively minor compared to its monetary role.

This makes gold eerily similar to Bitcoin – it has value largely because we collectively agree it does. Proponents of gold-backed currency often overlook this circular logic. While fiat money has value because some entity says so, gold is ultimately in the same boat. Backing currency with gold just pushes the “trust problem” down one level.

3. Store of Value… By Consensus
We call gold a “store of value,” but this is only true because everyone says so. It has limited intrinsic value beyond our cultural attachment to it. And while gold can back currency, gold itself isn’t something you can easily spend.

4. Regime-Switching Behavior
The most fascinating aspect of gold from a trading perspective is its regime-switching behavior. Much more than bonds, gold tends to flip between being a:

• Safe-haven asset during crises
• Risk-on asset during certain inflationary environments

These regime shifts are identifiable in retrospect but notoriously difficult to predict in advance. This bifurcated nature makes gold both valuable and frustrating as a portfolio component.

Gold and other precious metals are fundamentally different from stocks and bonds, so allocating a portion of your portfolio to them makes mathematical sense for diversification. But I wouldn’t rely on it as a consistent, all-weather hedge.

Now, let’s examine how to actually gain exposure to these peculiar assets.

The Precious Metals Market Landscape

There are several ways to gain exposure to precious metals, each with distinct characteristics:

1. Physical Ownership

This refers to the buying and holding of actual gold/silver bars or coins.

Pros:

• Complete ownership without counterparty risk
• Can’t have trading halted during financial crises
• Privacy (though decreasingly so with regulations)
• A tangible asset you can physically access

Cons:

• Storage costs and security concerns
• Wide buy/sell spreads (typically 3-8%)
• Illiquidity (can take time to convert back to cash)
• Not practical for active trading

Physical metals can make sense for some people as a small “insurance policy” portion of your portfolio, but they’re impractical for most trading strategies.

2. Exchange-Traded Products (ETFs, ETNs)

These are financial products tracking metal prices, traded on stock exchanges.

Examples:

• GLD, IAU (gold ETFs)
• SLV (silver ETF)
• PHYS, PSLV (Sprott’s physically-backed trusts)

Pros:

• Highly liquid with narrow spreads
• Low costs (expense ratios 0.25-0.75%)
• Easy to trade through regular brokerage accounts
• Available in tax-advantaged accounts
• Some options are physically backed

Cons:

• Counterparty risk (dependent on the fund structure)
• Some products use derivatives rather than holding physical metal
• Potential tracking error over long periods
• Annual fees erode returns

ETFs are the most practical vehicle for most investors and traders. In some circumstances, you might prefer physically-backed ETFs like PHYS where the metal is actually held in allocated storage. For active trading strategies, the liquidity of products like GLD is hard to beat.

3. Futures Contracts

These are standardized contracts for future delivery of precious metals.

Examples:

• GC (COMEX Gold futures)
• SI (COMEX Silver futures)
• PA, PL (Platinum and Palladium futures)

Pros:

• High leverage
• Extremely liquid, especially front-month contracts
• Low transaction costs for large positions
• Clear price discovery
• Useful for hedging physical holdings

Cons:

• Roll costs when contracts expire
• Significant capital requirements
• More complex than spot trading
• Contango/backwardation effects

Futures are the professional’s playground and the most efficient vehicle for systematic trading of precious metals. Most of the strategies I’ll describe later are implemented most efficiently through futures, but they require more sophistication and capital than ETFs.

4. Contracts for difference (CFDs)

Contracts for difference (CFDs) offer leveraged exposure to price movements without owning the metal. You profit from the difference between opening and closing prices.

Pros:

• Low barriers to entry
• Short-selling capabilities
• No physical ownership required
• No expiration dates (though carrying costs apply)

Cons:

• Counterparty risk with your broker
• Spreads in prices can be high
• Interest charged to keep overnight position might erode gains
• Margin call exposure

While CFDs are easy to use, as traders don’t have to worry about rolling contracts on expiration, between spreads and interest charged to keep your position open, they tend to err on the expensive side compared to other instruments. And the counterparty risk should not be downplayed.

5. Options on Metals

These are contracts giving the right (not obligation) to buy/sell metals at predetermined prices.

Examples:

• Options on GLD/SLV
• Options on gold/silver futures

Pros:

• Defined risk exposure
• Ability to trade volatility, not just direction
• Leverage without the funding costs of futures
• Can implement sophisticated strategies (spreads, condors, etc.)

Cons:

• Complex pricing affected by multiple factors
• Time decay works against long option positions
• Often, wide bid-ask spreads
• Requires skill and experience

Options are powerful tools for specific scenarios, particularly for exploiting volatility regimes in precious metals or implementing tail-risk hedging strategies. They’re not ideal for beginners, but can be incredibly useful for specific tactical trades.

6. Mining Stocks/ETFs

These are a means of owning shares in companies that extract precious metals.

Examples:

• Individual miners (NEM, GOLD, AEM)
• Mining ETFs (GDX, GDXJ, SIL)

Pros:

• Operational leverage to metal prices
• Potential dividend income
• Exposure to company-specific catalysts
• Easier to analyze using traditional equity metrics

Cons:

• Company-specific risks (management, jurisdiction, reserves)
• Often more volatile than the underlying metals
• Imperfect correlation to metal prices
• Subject to broader equity market risks

Mining stocks are a different animal entirely from the metals themselves. They’re equity investments first, metal investments second. They typically offer leverage to metal prices, which cuts both ways. They’re worth considering as a tactical overlay, but not as a direct substitute for metal exposure.

Systematic Strategies for Precious Metals

Now for the fun part. Let’s look at how we can systematically trade these markets instead of just buying and hoping for the best. I’ll look at gold for most examples, but you can probably try something similar with other precious metals as well.

It goes without saying that past performance and successful backtests are not indicative of future returns, and the samples showcased here did not include trading costs or taxes, but they might be a good starting point for your research.

1. Time Series Momentum Strategies

Time series momentum (TSM) exploits the persistence of price trends in metals.

Theoretical foundations:
TSM is based on the idea that assets tend to continue moving in the same direction over intermediate time frames (1-12 months). In gold markets, this effect can be amplified during periods of macroeconomic uncertainty, where safe-haven demand creates self-reinforcing price trends.

A simple implementation:

1. Calculate the 12-month trailing excess return for gold futures
2. Go long if the return is positive, short if negative
3. Rebalance positions monthly

Performance:
Trend following is incredibly noisy on individual assets. Nevertheless, using GLD prices, which I extended back to 1996 using gold mutual fund data, the long-only version of this approach delivered similar returns (CAGR 6.1% vs 6.8%) to buy-and-hold with lower drawdowns (max drawdown 29% vs 43%):

2. Mean Reversion Strategies

While momentum might dominate at longer timeframes, mean reversion can work well at shorter horizons.

If we believe that two metals share a relationship, then we can potentially exploit it through pairs trading. For example, when the gold/silver ratio gets too extreme, we can bet on it reverting.

Any single pair tends to have noisy returns, but trading a portfolio of pairs can be a good way to smooth things out.

Here’s the results of a GLD/SLV pair trade over the last few years:

3. Roll Yield Exploitation Strategies

Gold futures markets spend most of their time in contango (futures prices higher than spot) and much less in backwardation (futures prices lower than spot). This creates a “term structure premium” that can be systematically harvested.

A gold strategy that shorts front-month futures and buys longer-dated contracts has delivered about 5% annualized since 2000.

When gold futures are in backwardation, buying the front month and shorting longer-dated contracts can also be profitable. In 2020, gold futures went into backwardation for a brief period, and this approach generated almost 20% in less than three weeks.

4. Volatility Risk Premium

Gold options typically trade at implied volatilities higher than realized volatility – a persistent premium that can be captured through systematic selling of options. Historically, gold options have become more mispriced during crises as investors overpay for “catastrophe insurance.”

Of course, selling options is a significantly negatively skewed strategy – lots of small wins and occasional large losses – and should be sized with this in mind.

5. Seasonal and Calendar-Based Strategies

Here’s an effect that might sound strange: historically, gold has tended to go up on Fridays – a phenomenon that’s statistically robust but lacks a compelling explanation.

A strategy that buys gold at Thursday’s close and sells at Friday’s close has done surprisingly well:

This is a classic example of needing to decide where you stand on the “stats vs. reasons” continuum. Do you need to understand why something works before you trade it? Or is statistical significance enough?

I tend to favor compelling narratives over statistical significance because it’s easy to find something that looks good through chance alone. Having said that, the Friday effect has remained consistent through bull and bear markets in gold, suggesting there’s something structural rather than coincidental at play.

Portfolio Considerations: The Regime-Switching Hedge

Now let’s talk about how gold fits into a broader portfolio context, given its peculiar regime-switching nature.

The traditional view of gold as a reliable hedge for equity risk is only partly accurate. In reality, gold’s correlation with stocks is highly unstable, shifting dramatically based on:

1. Inflation regime (rising vs. falling)
2. Real interest rate direction
3. Dollar strength/weakness
4. Market stress levels

Nevertheless, a simple long-only volatility-scaled risk premia harvesting strategy that includes a gold allocation has outperformed the same strategy consisting of only stocks and bonds:

Risk Management for Precious Metals Trading

No discussion of systematic trading would be complete without addressing risk management, which is particularly important in the volatile world of precious metals.

Dynamic Volatility Targeting

Adjusting position sizes inversely to gold’s 30-day realized volatility improves before-cost risk-adjusted returns.

This targets a constant annualized volatility, scaling back when things get crazy.

In practice, constant rebalancing is not a good idea due to costs. But if you rebalance when your exposure gets out of whack with what you want by a certain percentage (say 10-20%), you’ll keep your risk under control without destroying your account with transaction fees.

The formula for volatility targeting is straightforward:

Position Size = Target Volatility / Realized Volatility

Position sizing is one of the few things we can control in the markets, and it makes sense to rebalance your exposures during volatile periods. There is no reason to accept the risk the market gives you when you can control it through position sizing.

Practical Implementation Considerations

Let’s wrap up with some practical tips for implementing these strategies:

For Smaller Accounts (Under $100k):

1. ETF-based implementation – Use liquid ETFs like GLD or IAU for gold exposure, SLV for silver.
2. Simplified timing models – Focus on longer-term, lower frequency signals.

For Larger Accounts (Over $100k):

1. Futures for efficiency – Use futures (mini futures are available if you have a smaller account) to gain more capital-efficient exposure.
2. Combination strategies – Capital efficiency makes it easier to trade multiple edges.
3. Cross-asset signals – Investigate signals from related markets (USD, rates, volatility etc.) for more robust models.

Conclusion: A Systematic Approach to the Oldest Asset Class

Gold and precious metals offer unique portfolio benefits, but they’re often approached with more mysticism than methodology. By applying the systematic frameworks we use for other asset classes, we can extract more value while managing the unique risks these markets present.

To summarize the key takeaways:

1. Gold’s price dynamics are complicated – it’s a 6,000-year-old asset whose value largely derives from collective belief.
2. As a portfolio component, gold switches between being a hedge asset and a risk asset in ways that are hard to predict.
3. Despite this complexity, gold exhibits exploitable patterns through momentum, mean reversion, risk premia, relationships with other assets, and calendar effects.
4. The diversification benefits of gold are real, but shouldn’t be overestimated – it’s one tool among many.

Whether you’re looking to add a small strategic allocation or actively trade these markets, I hope this guide gives you a solid foundation for thinking about precious metals from a quantitative perspective.