The Silver Lining of Gold Fever

As strongly as I believe in the future for gold as a commodity, and also for those commodity-producers, I cannot avoid reaching the conclusion that the future is brighter still for gold's under-appreciated “little brother”. And the arguments for silver have NEVER been stronger than today.

Any comparison between gold and silver must start with the enormous difference between the two when it comes to consumption. Gold is “consumed” though its use as currency, from investor demand, and as jewelry. None of those uses destroys, or uses up gold, so essentially all the gold that has even been mined is still available somewhere in the world, with a small amount added each year through production.

The situation for silver is entirely different. Silver has not been used as currency for many decades. Until very recently, investor demand was not a large “consumer” of annual silver production. Considerable amounts are used in jewelry, but that is still a minor component of “consumption".

The majority of silver mined each year is used “industrially”. In other words, it is used in some process, or in the creation of some product. In almost every one of these applications, the silver is used in very small amounts (relative to the particular process or product). Because these tiny quantities of silver are NOT recoverable, most silver is effectively consumed in the literal sense: it is gone forever.

In just the last century, most of the world's stockpiles of silver have been “consumed” in this manner. When it comes to the relative, total supplies of gold and silver, the ratio of silver to gold in the world steadily shrinks every year. Many estimates of existing stockpiles of silver to gold are of ratios of 6:1 or less.

Silver is seventeen times as common as gold in the Earth's crust, indeed, the long-term gold/silver price ratio is 15:1. The ratio in more recent decades has been closer to 50:1, but even that looks conservative in comparison to the greater than 70:1 ratio as of this writing. The price ratio has been getting bigger and bigger, while the supply ratio has been getting smaller and smaller.

One of the more elementary principles of economics is that a commodity which is under-priced will be over-consumed relative to its abundance. And this is exactly what we have been seeing over the last century. With the gold/silver price ratio absurdly out of balance relative to the amount of raw ore on our planet, and with that ratio declining every year, at some point there must be a dramatic rebalancing in price between gold and silver.

Given that much of the world's silver has been permanently depleted, and given what the long-term price ratio was while silver was abundant, it is natural to assume that restoring a sustainable equilibrium between gold and silver would result in (at least temporarily) a gold/silver price ratio lower than the historical average, in other words below 15:1.

If we were to make the ridiculous assumption that the price of gold would not rise above $1000, this still suggests a peak silver price of at or near $100/oz. In reality, the price of gold is almost certain to rise many multiples of today's price. However, if we were to predict a conservative “ceiling” for the price of gold at $2000/oz, then that would imply a peak for silver of close to $200/oz, a rather large leap from today's lowly price of $13 US.

In support of this long-term goal, I offer only two of many arguments. First, there is an established history of silver “outperforming" gold as the precious metals market nears a peak. In other words, before gold has hit its high, the gold/silver price ratio will swing dramatically in favor of silver.

Second, and equally important: we are already seeing investors squeezing out jewelry-buyers for the dwindling available supplies of gold. With the price of gold going higher, and the world in the midst of a recession, this trend can only accelerate.

By default, this means a dramatic increase in the demand for silver jewelry. The other alternative to this scenario is that the world's women simply reduced their desire to own and wear jewelry. I dismissed such a ridiculous concept from my mind, instantly.

So at a time when the amount of available silver in the world has not been this low for nearly a thousand years, we face a market where we have every reason to suspect that silver will outperform gold going forward. In addition, we have the imminent prospect of a large shift in demand from gold jewelry to silver jewelry.

While gold's bright prospects are in part the result of dark, economic “clouds”, don't forget those clouds will likely have a silver lining.

Comments

[bagman432:]

When the Fed's quantitative easing leads to painful inflation, people will finally wake up and realize what's happening to their purchasing power. By the time this happens gold will likely be priced way beyond the reach of all but the super rich. At this point, silver will quickly become the only precious metal that the average investor can afford. A frenzy could follow that would push silver prices way beyond your highest estimates. In fact, silver could become the best investment of the next decade.

May 06 09:11 AM

[yellowhoard:]

If the economy sputters again, and copper, zinc, and other mines shut down what little production is still left, the amount of silver will diminish ever more.

In such a situation, the Fed will be using QE like there is no tomorrow at the same time as the supply of silver if shrinking.

You've got to love the fundamentals.

May 06 09:30 AM

[Sakata:]

Once again I agree with all you are saying. But my skeptical side forces me to ask how likely it is to happen.

According to all the law of logic and supply and demand, silver should go way high. Maybe higher than the price of $200 you qoute. I read somewhere recently, I think in an article by Ted Butler, that ultimatley silver and gold would be the same price. But will the public go for that? Will the brakes be put on before a 10:1 ratio is reached? I have a feeling that they might, simply because such a low ratio is not part of the expectations of people in the current financial business. Most are relatively young and don't remember a ratio of 15:1. And don't forget, large scale financial institutions control the price, not small investors.

I have no doubt your numbers are correct. Trying to decide whether your conclusions are correct leaves me sitting on a fence, undecided. But does it really matter? Silver if going to be worth a whole lot more pretty soon and those of us who have it now are going to be smiling.

May 06 09:51 AM

[Jeff Nielson:]

Thanks again for the insightful comments, everyone. Sakata, if you would like a cure for your pessimism, just think about silver jewelry. The price of gold jewelry has already started to exceed affordability, in important markets like India - with the switch to silver jewelry gaining momentum. For many reasons, as the price of silver INCREASES, the demand for silver jewelry will ALSO increase. I don't ever foresee 1:1 pricing with gold. However, a ratio of 15:1 (the long-term average) seems reasonable.

May 06 10:48 AM

[Whippet:]

Thanks, Jeff- I like your perspective on silver jewelry demand. I personally consider silver to be the lowest risk play right now- lower than gold, Tbills, equities- for the reasons you describe. In a recovery, industrial demand will rise. In the status quo, price will rise with the ongoing fears of imminent hyperinflation. In another drawdown, it will rise due to safe haven investing, especially as a proxy for relatively expensive gold by shrewd and also poorer investors.
Long SLW, physical silver

May 06 11:28 AM

[Boxed Merlot:]

"Cross of Gold" notwithstanding, gold, silver and copper appear to be reasserting themselves as the true basis of trade / currency. I'm fairly young no doubt in comparison to many of you out there, but I believe the US has been fortunate to have our coinage of pennies, nickels, dimes, etc in our past, (primarily before 1964), to be able to create the illusion our current federal reserve notes have significant backing. Then again, nearly 14 trillion in GDP/GNP goes a long way in sustaining such an illusion. (But for how long?) I'm glad to see more discussion of the ratio between au/ag and think it needs to be better represented in coinage than the zinc based junk currently being pawned off on the public at large.

May 06 12:17 PM

[ignoramusma...:]

Boxed Merlot, ya mon! Right on, dude! Has anyone taken a close look at the any of the newer coins? Take some out of your pockets right now and compare them to coins from a time when somebody gave a damn like from the 60's or 70's (even the 80's weren't too bad). Not only are the materials cheap, the depth of the coining on the new coins is pathetic. The cheap junk being produced is a symptom of our culture. Virtually every culture in history has engaged in this practice to enable deficit spending - right before they went down the drain. Our culture will be no different. Good riddance, I say.

May 06 01:48 PM

[Whippet:]

You think the schlock we have now is bad? At least it's still clad nickel and copper, for the most part. There are rumors of aluminum coinage in the works. To be proposed as an Alcoa bailout I presume...
If the late 19th century was the "Gilded Era", I guess we'll go down as the "Anodized Era".

May 06 02:56 PM

[chux08:]

The cheapest silver bullion in relation to any premiums charged is still good ol 90% U.S. coinage, more commonly known as junk silver. In fact, I just sold some Yamana and Silver Wheaton shares for a nice profit and decided to buy a "half a bag" (about 357.5 Troy ounces) to hold a little closer to home and until the future is a little....clearer. Oh, I like the producing miners but everyone should have some of those miners' final product stashed safely somewhere. Think about this: Why not hold some 90% silver legal tender that still happens to be....money? (Even you paper dollar fanatics should understand that.)

That last comment was used to incite comments from those that DON'T hold precious metals, as we who do, already know that gold AND silver IS REAL money....and always has been.

May 06 10:12 PM

[capt Brian:]

Man, again, I wish all of you would go back 20 years, and look at what was being said about Gold, silver, and the ratio.

What I am reading now is the same thing, but now more powerful than before. Before, was sales tactics or very wise men. I think sales men if u want my guess, but by default, I think they did not know how right they would be, took a lot longer than perceived, but I think it is time now. Get ready for the storm.

I was selling Mocatta Gold and Silver options ( and yes even platinum) more than 20 years ago. I have coins from those days when silver was so cheap, the boss would bring us a Mexican una onza plata pura and toss it on the desk for making a sale. I usta give them to the waitresses at a local restaurant for a tip. ONE ounce of silver for a grin. yup. Then things started to happen, I quit giving them away, quit being a broker, and started my own lil business, and within two years, [18 years ago] I started keeping physical metals, and still have them. I have not sold one ounce of gold silver or platinum in all this time, (save for one of the new gold Buffalos I replaced later at the same price and made $300 on it) [that was a week ago] In November I began trading leveraged account silver at a known name brokerage, made 859% in less than 3 months, and took the money back and began to buy silver and gold since then, (Jan, '09), now platinum, now PF 70 coins, and I want more silver. I buy on dips and happy as a lark when silver and gold take another bath, as I continue to buy more.

grins to alla u

Capt Brian, navigating thru the storm

May 07 01:28 PM

[capt Brian:]

And always will be, Hell, it may be the new global currency that Russians and Chinese want so bad, why the heck do you think China has doubled is reserves recently?

not enough gold to do it, well, perhaps China will set the silver standard for the world, wouldn't that be a hoot.
look into currency swaps that China is doing to go around buying dollars to use with countries. Nice plan to torpedo the dollar while our government is more interested in saving the money it takes tot run a navigation system (loran) so they can give the money to poor people. Who will begin to use it wisely, although they never used a dime wisely in their lives.


On May 06 10:12 PM chux08 wrote:

> The cheapest silver bullion in relation to any premiums charged is
> still good ol 90% U.S. coinage, more commonly known as junk silver.
> In fact, I just sold some Yamana and Silver Wheaton shares for a
> nice profit and decided to buy a "half a bag" (about 357.5 Troy ounces)
> to hold a little closer to home and until the future is a little....clearer.
> Oh, I like the producing miners but everyone should have some of
> those miners' final product stashed safely somewhere. Think about
> this: Why not hold some 90% silver legal tender that still happens
> to be....money? (Even you paper dollar fanatics should understand
> that.)
>
> That last comment was used to incite comments from those that DON'T
> hold precious metals, as we who do, already know that gold AND silver
> IS REAL money....and always has been.

May 07 01:32 PM

[5142152-337:]

Jeff, thank you so much for the article. Keep it coming!

May 07 09:06 PM

[Mike10613:]

In the 1930's depression the only country not to be affected was China who had a silver standard rather than the gold standard. Maybe there is still a lesson to be learned from history? But both gold and silver will appreciate in value with quantitive easing and so will all other metals and even precious stones.

May 08 06:15 AM