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The Gold Silver Ratio

Silver Prices May Push to $406.35/oz

Written by Greg McCoach
Posted March 12, 2010 at 7:37PM

Silver is often perceived to be subordinate to gold. But history clearly shows that during precious metal bull markets, silver outperforms gold.

Just consider the precious metal bull market of the 1970s...

Between 1970 and 1980, gold prices increased from the Brenton Woods fixed price of $35 an ounce to a high of $850. It was a 2,329% jump in the ten years. Meanwhile, silver went from about $1.50 in 1970 to over $50 an ounce in 1980 — a 3,233% increase.

So far, gold has already crossed its nominal high of $850 an ounce. But silver has come nowhere near its 1980 nominal high of $50 an ounce... I think this is all about to change because...

Silver is Money, Too

The investment community’s general neglect of silver has historical origins. For thousands of years, silver — not gold — was the coin of the civilized world.

One of the most complete histories on silver can be found in the book "The Silver Bonanza" by Franklin Sanders and James Blanchard. The book begins with the following quote from Milton Friedman: "The major monetary metal in history is silver, not gold."

Evidence of silver being used as money extends back to at least 4,500 years. According to "The Silver Bonanza," the first mention of silver in the Bible is in the Old Testament in roughly 1850 BC. During King Charlemagne’s reign, silver was the only legal tender metal.

 

Early colonial America also preferred silver to gold. Settlers rigged the gold-silver ratio to encourage the flow of silver into the United States. It took 15.5-16 ounces of silver to buy one ounce of gold in the rest of the world but, by decree, it took just 15 in early America.

Silver was the major monetary metal for the U.S. until 1873 when it was demonetized; when this occurred, its richer cousin gold was given the sole key to the currency kingdom.

Gold has received all the accolades and nearly all the ink ever since. Most "hard money" advocates will talk about gold as money for hours, as if it were religion. Lowly silver gets little or no time at all...

But don’t shy away from silver. Gold always moves first in a precious metals bull market because it is seen more as money, yet silver posts better percentage returns nearly every time there is a sustained rally in gold. So why do people still ignore silver, especially as it is priced so reasonably compared to gold right now?

There are five reasons that I see:

  1. The 1873 demonetization of silver occurred roughly 100 years prior to the official end of the gold standard. Investors have short memories. So when they think of metal-backed currency, they think of the modern era’s more recent experiences with gold, despite silver’s richer monetary history.

  2. Silver is known as an industrial metal, while gold is considered an alternative to currency, an inflation hedge, and a legitimate investment tool even by those not necessarily in the "hard money" camp. Yet silver functions often as a better inflation hedge alternative currency as well, even though few investors believe it.

  3. Even though there is far more silver on earth than gold, the silver market is much smaller than the gold market. This makes transactions much more visible and the market more susceptible to large fluctuations. (Note: There is approximately 17.5 times more silver than gold in the world; coincidently, this is very close to the 16 to 1 monetary ratio of silver to gold that existed for thousands of years.)

  4. The discovery of the great Comstock Lode in 1859 caused the great decline in silver as a monetary metal. The supply of silver gushing out of Nevada simply overwhelmed its monetary usefulness with the result that silver became viewed as an unreliable standard for paper currency.

  5. As industrial economies of the world grew and photography was invented, a growing demand for silver began emerging for uses in these new areas. This industrial demand conflicted with silver’s monetary demand, which also caused volatility to silver’s purchasing power.

While there is nothing to do about the tendency of investors to have short memories, there is a definite substitution effect between silver and gold. Silver may not be seen as a currency alternative right away... but its monetary history eventually prevails and catches up and usually surpasses gold.

As problems with the dollar, euro, and other fiat currencies continue to worsen, some of the wealth fleeing paper money will flow into silver, causing the ratio of the precious metals to decline — just as it has since the ratio was over 100 in the early 1990s.

Eventually I see silver returning to its 16 to 1 ratio with gold before all is said and done with the secular bull market in the precious metals.

What does that mean for how high silver could go?

Well, if gold is $1,200 an ounce and you divide by 16; you would get $75 an ounce silver. If gold goes to make a true inflation adjusted new high — which would be roughly $6,500 an ounce — silver (based on the 16 to 1 ratio) would be $406.35 an ounce!

Right now the silver to gold ratio is about 60 to 1, but with what I see happening in 2010... I think you will begin to see this ratio cut in half.

For this reason, I think it is time to add more exposure to silver in our recommended companies, and I am on the hunt for new silver stories.

Good Investing,

Greg McCoach
Editor, Wealth Daily
Investment Director, Greg McCoach's Insider Alert and The Mining Speculator

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