Gold is hot! After ripping through the $1,000 level last week, the godfather of precious metals topped off at $1,033.90 an ounce on Monday as the US dollar continued its abyssal downward spiral in the wake of the Bear Sterns implosion. The greenback has fallen to all-time lows against many world currencies, resulting in a 20% gain in gold for the year.
Gold is hot. But silver is hotter!
Hi-Ho Silver, Away!
Since the beginning of 2008, silver spot prices have increased from $14.86 an ounce to as high as $21.349.
This represents an impressive 44% increase, or over twice gold’s 20% year-to-date gain.
Back in December, Greg McCoach and I got together to talk specifically about the outlook for investing in silver in 2008. And after looking at the fundamentals driving prices, we had no problem coming to the conclusion that there was, and still is, exceptionally significant upside to silver as an investment.
In a Gold World article titled “Silver Investing Outlook,” we pointed out that global silver demand is expected to exceed supplies this year, despite an expected surge in mine production and lower fabrication demand. Much of the bidding will come in the form of investor demand, as speculators ramp up buying the monochromatic metal this year as an additional hedge against inflation and the falling US dollar through physical and ETF investment. We expect this deterioration of silver’s supply-demand fundamentals to be the driving factor for prices in 2008.
“How high will silver prices go by the end of this bull cycle?” is the $64,000 question. Of course, we’ve heard the über-bullish predictions of silver reaching $400 an ounce, $500 an ounce, and even $871.38 an ounce. And while I can appreciate the excitement and zeal that these fellows have for gold’s closest relative, I believe that there’s really little to no chance of silver prices increasing to those levels in the foreseeable future.
However, if we consider the average gold/silver price ratio and the inflation-adjusted highs of the last metals bull market as meaningful tools to help determine the top for silver this time around, we see that silver prices have a good chance of reaching over $50 an ounce, and could even soar over $150. These estimates represent an approximate 250% to 650% increase from current levels.
$50 an Ounce… Are You Investing in Silver Yet?
The gold/silver price ratio is essentially the number of silver ounces required to buy one ounce of gold at current spot prices. For example, if the gold is trading at $1,000 an ounce and silver is trading at $20 an ounce, the gold/silver price ratio would be 50:1, or 1/50th of 1,000. To calculate the gold/silver price ratio, you need only to divide the current price of gold by the current price of silver.
This ratio has fallen significantly since the beginning of the current metals bull market and even more so since the early 1990s. In the chart below you’ll see a near two-decade decline in the gold/silver ratio, from 100:1 in 1990 to about 50:1 today, which is also the average ratio over the past forty years.
The “historic” gold/silver ratio, which has actually been traced back to as far as 4,500 years ago, is 16:1. This 16:1 ratio has determined gold and silver’s price relationship for thousands of years. In fact, if I had a chart that was ten feet long and represented the past 2,000 years of human history, the gold/silver ratio would remain under 16:1 for all but the last 7.5 inches. I can only speculate as to the reasons for the ratio’s relative stability. I would guess it probably arises from the ratio of the earth’s silver to gold reserves, which geologists have long estimated at 17.5:1.
For the year, the gold/silver ratio has fallen dramatically, reflecting silver’s outperformance of gold. Since the beginning of 2008 the gold/silver ratio has dropped nearly 12% and, as I just mentioned, with silver prices at ~$20 an ounce and gold at ~$1,000, the gold/silver ration is approximately 50:1.
If we assume that gold will at least match its inflation-adjusted price high of $2,500 an ounce during the metals bull market of the 1970s and that the gold/silver ratio will remain steady at 50:1, which is the forty-year average, we can estimate that silver prices will touch at least $50 an ounce, or 1/50th of $2,500 gold.
Silver at $150 an Ounce
Now let’s assume that the gold/silver price ratio will drop to its historic level of 16:1 during the mania stage of the bull market. With gold at $2,500 an ounce, a 16:1 gold/silver ratio would put silver prices at $156.25 an ounce.
There’s no doubt that silver is a long way from the $150 level. And, yes, a 650% gain from current silver prices seems unlikely. But before you count out silver at $150 an ounce, you must consider that this figure is very close to the inflation-adjusted high for silver of $146 an ounce.
Also please consider that these figures are based only on gold reaching its inflation-adjusted high of $2,500 gold. There are many, including Greg and myself, who believe that gold could test the $3,000 level once this bull market plays itself out.
Of course, everyone has their own opinion on how high gold will go. With that in mind I created a table (below) that shows silver prices based on several gold/silver ratio scenarios and their relationship to the price of gold.
Without a working crystal ball I cannot say with absolute certainty where silver will top off. But I feel extremely confident telling you that we can only expect higher prices as the current commodities bull market continues to mature. Continue to invest in silver, by all means.
Until next time,
Luke Burgess
