Invest in Silver Over Gold

Gold and silver bugs often debate whether to invest in gold or silver at any given time, in attempt to buy the relatively undervalued metal either for long or short term time horizons. Often times historical ratios, among other metrics such as regression analysis, are used to determine the answer. Of course these are used after the supply-demand dynamics have been carefully looked over, but nonetheless, can be of great use. The following paragraphs describe my reasoning for favoring silver over gold.

As we get closer to the day inflation kicks into full force, it is worth noting some common gold:silver ratios. History has more or less showed us that the historical ratio has averaged between 20:1 - 25:1 (depending on the measured time horizon). I personally like to break it down using different ratios for periods of low to moderate inflation and high and double digit rates of inflation. As a rule of thumb for times of low to moderate rates of inflation (below 5 or 6%), I use a ratio between 45:1- 55:1. During times of high to double digit inflation (late 70's style) I revert back to the historical ratios between 15:1-30:1. Given the current low level of "headline inflation" (which is nonsense anyway), which has to inevitably rise over the coming decade, silver is very attractive on the gold:silver ratio, currently at 64.36. Though inflation is said to be "very low" (according to the governments convoluted measure), my expectation for it rise sharply over the coming years, makes silver an absolute bargain.

Take a conservative estimate of the future gold price when inflation is in full force, say $1300/oz, silver using a ratio between 25:1 to 40:1, would give you a price somewhere between $32.5 and $52.5. It need not even be take that far to see the price appreciation potential. Assume the price of gold remains at $1060/oz throughout the time when inflation plagues consumer prices, silver should still be between $26.5-$42, which is a substantial rise on a percentage basis.

The Supply-Demand dynamics favor silver by a mile for one simple reason but important reason, discussed in detail in my previous article Silver Unmasked. The past decade of research has uncovered the vast array of applications from medical to technological uses, many of which will become the "gold standard" in various fields. The article briefly discussed the lack of reserves near the earth's surface and the implications to future price of this metal. So in other words, while gold may be the ideal inflationary hedge, silver is a close second but also has a long term catalyst (increasing industrial uses) to make silver a likely outperformer. Gold lacks industrial demand almost altogether, and is often recycled. Silver has and will have increasing industrial uses from such products as the silver-oxide battery, which will take substantial market share from the much inferior batteries "lithium Ion" currently used.

Though the first two measures have been successfully used by many investors (especially gold and silver bugs), I would just like to add a recent regression analysis I ran using 6 years of weekly gold and silver prices (Jan 2002 - Feb 2008), proved very statistically significant (the time period was chosen as it was a time of low to moderate inflation). Of the nearly 300 observations, the regression output using the equation Y= -2.7571 + .022929(X) (Silver = -2.757 + .022929 * the market price of gold), had an extremely high systematic relationship of 96.9%. In other words, only 3.1% of the equation mentioned above was unrelated to the price of gold. I also did random sampling, taking the weekly gold price in February over the six years measure, which forecasted what the price of silver SHOULD be given the prevailing gold price. The mean difference was 3.4%, which is much higher than I would have expected. It is not to say that I buy into this analysis, but it is just another tool in the toolbox now. According to the derived equation, silver should be trading at $22/oz.

Conclusion: Using 3 basic methods in an attempt to figure out the relatively undervalued metal, silver is sharply undervalued given the current spot price of $1060/oz for gold. The closest estimate of what silver should be relative to gold, means silver is 30% undervalued (at minimum)

Comments

[svosavvy:]

or is gold 30% overvalued

Nov 03 10:17 AM

[Steve in Gr...:]

Thanks, H, for the helpful note. I think the silver-gold ratio is at historically low levels (as are platinum, palladium and rhodium to gold) because the economy is in recession and silver has significant characteristics of an industrial metal. If the markets take another leg down, silver will go down with them. Gold will retain its value since it is a monetary metal and it is getting to be the only game in town in terms of a monetary store of value . The silver-gold ratio will return to normal when the economy begins to recover making big money for those who hold silver.

Nov 03 10:30 AM

[secmaven:]

When JPM's short selling on the CRIMEX is curtailed we will see higher silver prices...not before.

Nov 03 11:48 AM

[Timothy Don...:]

i like gold equities. check out san gold. the stats speak for themselves: www.goldalert.com/gold.... more lucrative than investing in commodities or etfs (also more risky, obviously)

Nov 03 12:10 PM

[Hyperinflation:]

I think the market is grossly overvalued at 10k. I think the next bear market decline will bring the dow somewhere between 8000-8500


On Nov 03 08:16 PM Harvard_Scholar wrote:

> Market may still be overvalued
>
> good articles: financeopinionss.blogs...

Nov 03 08:51 PM

[Hyperinflation:]

Couldn't agree more, I was just pointing out why I prefer silver in the long run at current prices. I think silver as well as gold conitnue to put in higher lows and don't expect Gold to drop below $950 and silver below $14.5 - $15. I think many buyers would come in at that and any significant decline (10-15%) would be very short lived. But who knows? I just think silver in general under 18-20/oz is an incredible bargain if you have a long term time horizon.


On Nov 03 10:30 AM Steve in Greensboro wrote:

> Thanks, H, for the helpful note. I think the silver-gold ratio is
> at historically low levels (as are platinum, palladium and rhodium
> to gold) because the economy is in recession and silver has significant
> characteristics of an industrial metal. If the markets take another
> leg down, silver will go down with them. Gold will retain its value
> since it is a monetary metal and it is getting to be the only game
> in town in terms of a monetary store of value . The silver-gold
> ratio will return to normal when the economy begins to recover making
> big money for those who hold silver.

Nov 03 08:56 PM

[Hyperinflation:]

I would comment about gold being overvalued, but I have had that conversation far to often and it never leads anywhere. Gold and silver's intrinsic value is always questioned by those who don't understand the dynamics of inflation i.e deficit spending, fractional reserve banking, so if you think gold is overvalued then you must be forecasting low to moderate inflation in the future?


On Nov 03 10:17 AM svosavvy wrote:

> or is gold 30% overvalued

Nov 03 09:02 PM

[solar jim:]

well, you see, its actually around 7,500 on a relative basis although the actual point number is in the 9,000's today. The reason is that the dollar has been debased since the dow was last at 10,000. Looking from the bottom in the 6'000's the dow has really only recovered to 7,500'ish due to the dilution of purchasing power of the dollar. Look no further to understand the rise in gold - and why it will continue to do so.


On Nov 03 08:51 PM Hyperinflation wrote:

> I think the market is grossly overvalued at 10k. I think the next
> bear market decline will bring the dow somewhere between 8000-8500
>

Nov 04 06:03 PM

[svosavvy:]

I was driving at your silver/gold relationship. I am actually bullish on silver, and have had and continue a long term position in it. As far as inflation goes to merely talk about monetary expansion is like getting the sports report but only getting one teams score and not the others. Fractional reserve banking and the "hot" (external inflows) money issue I agree are of extreme importance imho when considering prospects for inflation, however, I find it highly disconcerting that credit contraction is hardly brought up. Seems we only talk supply and not demand. How can we inflate when the consumer who is supposedly 70% of gdp has had their credit dry up. Sure the banks have been liquified via the gov't but the spenders are broke. I am a big believer in needs based inflation in time (couple of years'ish imho), I see food and energy inflating on demand, and consumer crap hitting the skids.

Nov 04 11:20 PM

[Hyperinflation:]

Credit isn't counted in the money supply and isn;t inflationary unless a bank lacks the funds / retained earnings to cover the loan losses. This is due to fractional reserve banking or where 90% of loans originated are done using phantom money ( that which the FED prints and under normal circumstances destroys that amount created from thin air, via electronic means). In other words, FRB isn;t inherently inflationary, but reckless governments have made sure that it becomes so.
As for loan losses that will default over the next 1-3 years, it will take a significant portion of the excess reserves the FED has pumped into the system to cover these. The amount used to cover loan losses is 100% inflationary. When you add in increasing amounts of deficit spending, potential healthcare legislation that increases our unfunded liabilities past the 80 trillion (NPV of future liabilities), accumulated debt ( which will destroy the budget even further when rates rise once again as interest payments grow to well over 1 trillion a year). Not to mention the money the government has been pouring down a black hold (bailouts), which is somewhere in the ballpark of 13-15 trillion. There is just to much money been created to starve off inflation more than a few more quarters.
- My 2 cents


On Nov 04 11:20 PM svosavvy wrote:

> I was driving at your silver/gold relationship. I am actually bullish
> on silver, and have had and continue a long term position in it.
> As far as inflation goes to merely talk about monetary expansion
> is like getting the sports report but only getting one teams score
> and not the others. Fractional reserve banking and the "hot" (external
> inflows) money issue I agree are of extreme importance imho when
> considering prospects for inflation, however, I find it highly disconcerting
> that credit contraction is hardly brought up. Seems we only talk
> supply and not demand. How can we inflate when the consumer who
> is supposedly 70% of gdp has had their credit dry up. Sure the banks
> have been liquified via the gov't but the spenders are broke. I
> am a big believer in needs based inflation in time (couple of years'ish
> imho), I see food and energy inflating on demand, and consumer crap
> hitting the skids.

Nov 09 01:59 AM

[svosavvy:]

All good and valid points. The credit I speak of is/was in the pockets of the 300,000,000 spenders of the US now gone by the wayside. I respect any intelligent conversation which is why I enjoy this, thank you. I maintain that nothing inflates without demand. I just don't see the track for big inflation continuing until we can outpace our rabid credit usage a la precredit crisis. I can believe in our "rebound" inflation which seems to have been taking place since march which appears to be a result of recovering from a "deflationary" shock. I would counter that I believe credit is inflationary and needs to be counted in the money supply, without credit you won't see demand, liquid growing inflating markets are built on demand. If the contraction of credit was added there would probably be a much different bottom line story. The inflationary leverage imho of a few years ago I think will be reeled in by the expected desire for regulation and oversight. I have no empirical evidence of my beliefs merely an anecdotal view from 30,000 feet. I would add that home prices as an example inflated on demand, credit was easy allowing a new pool of demanders to bid up prices on the greater fool theory to flip to the greater fool. Same idea on oil, and commodities I think it works great until the greater fool gets smart.

Nov 09 11:36 AM