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Silver Set to Shine

Written by Geoffrey Pike
Posted March 25, 2016

Silver is supposed to be the poor man’s gold. With gold trading around $1,200 per ounce and silver around $15 per ounce, it is understandable that someone with little money would buy silver.

This doesn’t mean, however, that silver itself is a poor investment.

It is important that every investor includes precious metals as part of his or her portfolio. The metals are a form of diversification and a hedge against severe price inflation.

Gold and silver are highly correlated. They tend to go up and down together. But they are not without differences.

Both can be used as industrial metals, but silver is more widely used for industrial purposes. Gold is used more for jewelry and investment purposes, and it is also rarer.

Both gold and silver have a long history of being used as a form of money. The two metals contain the properties that make them good for this: they are durable, divisible, homogenous, portable, and rare.

While almost anything can be used as a form of money, it is these properties where gold and silver stand out. Diamonds are rare, but if you cut one in half, the two halves are not of the same value as the whole thing.

Cows and pigs could be used as a form of money, but you aren’t going to carry a cow to the shoe store to buy a pair of shoes. In addition, cows eventually die.

Water is necessary for human life, but it doesn’t make a good form of money. You would need a lot of water to pay for your weekly grocery trip.

We are left with gold and silver as the best forms of money, just as they served for thousands of years. It wasn’t any government or central committee that decided on using gold and silver — it is what came about in the marketplace.

Our modern-day fiat currency has only been around for a short time. The entire existence of fiat currencies, without anything backing them up except for government promises, could be a short-lived experiment in the context of human history.

Still, even today, central banks around the world hold gold reserves. They may not admit this, but it perhaps adds a little bit more confidence to the currencies they control, even though the gold does not come anywhere close to backing up the currencies in circulation at the current prices.

But this is another difference between gold and silver: central banks do not own silver, at least that we know of. But they do hold gold.

Investing Differences

For investors, the main difference between gold and silver is that silver is far more volatile. We have seen this just in the last five years when the long bull run in metals turned into a bear market. Silver went from almost $50 to under $15. Gold went from over $1,800 to a low of just under $1,100.

In other words, in percentage terms, silver did far worse in the bear market. But in a bull market, silver will typically have larger percentage gains.

I generally favor gold over silver as an investment for this reason. It is more stable for your portfolio. You can have 20% of your portfolio in gold and gold-related investments for diversification and stability. It will help your portfolio do better in times of higher price inflation, which is when you need the bigger gains because your dollars are losing purchasing power.

I generally don’t recommend more than 5% in silver, and even this may be high. It is so volatile that even 5% will make for a bumpier ride for your portfolio.

Perhaps now may be one of the exceptional times to push the 5% threshold with silver if you have the stomach for it.

The Gold-to-Silver Ratio

One interesting statistic to look at is the gold-to-silver ratio. This will tell you the amount of silver you need to equal the same value of gold. For example, if the price of gold is $1,200 and the price of silver is $15, then it would take 80 ounces of silver to buy one ounce of gold. This is a gold-to-silver ratio of 80 to 1.

This is close to its current ratio. But five years ago, the ratio briefly went below 35 to 1. The historical average of the ratio is about 15 to 1 if you go way back in time before most central banks existed. But even in modern times, the ratio has briefly dipped below 15 to 1.

In order for the gold-to-silver ratio to get back to its old historical average near 15 to 1, either silver would have to go up a lot in price or gold would have to go down a lot (or some combination of the two).

It is not impossible that silver could go up while gold is going down, but it isn’t all that likely due to the typical correlation we see with the metals. Therefore, it would probably be one outpacing the other, but both heading in the same direction.

Of course, with the current uptick in 2016 and the madness of the central banks around the world, my long-term bet tends to be on a bull market for gold and silver.

If gold were to stay around $1,200 and the ratio returned to 15 to 1, then silver would have to spike up to $80 per ounce. If gold ends up at $2,000 per ounce with a 15 to 1 ratio, then you would be looking at silver trading over $130, or more than eight times its current level.

To be clear, there is nothing magical about the gold-to-silver ratio. There is nothing written in the laws of physics or economics that says we have to see a return to the historical average, or even anywhere close to it. But it is still an interesting statistic to note to show the realistic possibilities and potential.

During the bear market in metals in the 1980s and 1990s, central banks were typically selling gold, if touching it at all. Over the last decade or so, many central banks — especially China — have started accumulating gold reserves. In the short run, this has likely helped put a floor under the gold price that hasn’t existed with silver.

There is also a short-term threat to silver with a recession. When stocks were tumbling in January, it was interesting that gold was doing well, because that is not always the case with a recession looming.

If there is a recession in the near term, it may or may not be good for gold. Silver would likely suffer because of its use as an industrial metal.

But even if there is a recession, it will probably mean more central bank monetary inflation, which will ultimately help drive the metals higher if continued inflation is seen as a significant threat.

Investing in Silver

With the gold-to-silver ratio out of whack even by modern standards, and with silver down to less than one-third of its all-time high priced in dollars, now may be as good a time as any to dip your toe in the silver water.

You can buy actual physical silver in the form of coins, or you can buy an exchange-traded fund such as SLV. For short-term trading, it is probably better to buy the ETF to avoid the premium markups and hassle of storing it.

Another option is to buy mining stocks that primarily pursue silver. This is not for the risk-averse investor. Silver by itself is already a risky investment on its own. When you are talking about a silver mining company, you can add in leverage and the risks of any business, which in this case also may include geo-political risks.

Still, like most investments, with high risk often comes high reward. When the price of silver starts to boom, silver stocks are going to the moon. It would not take much to see some of these stocks go up 10-fold in a rather short period of time.

One example is Silver Standard Resources (NASDAQ: SSRI) based in Vancouver, Canada. It is currently trading just above $5 per share. When silver boomed in 2011, it hit a high of $35. In 2007, it briefly hit $42 per share. This gives you an idea of the huge profit potential of such a stock.

I am not ready to call a new bull market in precious metals yet, but we also don’t want to miss out on the ground floor. For that reason, it may be time to consider a small percentage allocated towards silver to let it run.

Until next time,

Geoffrey Pike for Wealth Daily

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