When Gold Drops, Silver's Uses Will Sustain Demand

Includes: GLD, SLV
by: Timothy O'Rourke

I started this article as a piece advocating a long position for silver before the market open Monday. But with gold up over $70 an ounce and silver only up around 1% (during trading as of Monday, August 08, 2011 at 11 am EST), Monday’s market has only reinforced my opinion that the price of silver is ready to pop.

Since at least 1792, the ratio of silver to gold has been tracked by investors as well as central bankers. In 1792, the United States mandated by law that the ratio of silver to gold must be 15 ounces of silver to 1 ounce of gold (i.e. 15 ounces of silver has the buying power of one ounce of gold). Once the gold standard was abolished, the price of silver was allowed to fluctuate against gold. Historically, the ratio of gold to silver has floated been 15 and 40, excluding global turmoil such as The Great Depression and World Wars I and II. While both gold and silver are very sound investments, two questions must be considered: Firstly, will there be a change in the silver/gold ratio and are either of these metals currently experiencing bubble pricing?

Upon researching these questions, there are several reasons to believe the historical silver/gold ratio is going to change. The industrial applications for silver are increasing almost daily. Since the age of exploration, silver has been known for its antibiotic properties; during that time, mariners would place a silver coin in their barrels of water to prevent it from turning sour. Since then, science has demonstrated that silver has important anti-microbial properties not found in other metals and that it can significantly decrease the risk of infection when used to coat plastic catheters and tubing. Hospitals and Pharmaceutical companies are now working together to transition from catheters without a silver coating to silver-coated catheters for all admitted patents to prevent patients from receiving an infection while in the hospital.

Recent advances in nanotechnology have also allowed oncologists to shrink tumors by injecting atomized silver into the tumorous tissue. Several research universities currently have clinical trials for a new breed of cancer drugs using atomized silver that will target the tumor specifically and kill it while not causing the typical side-effects to healthy tissues. (Please be advised I am not touting this as the cancer wonder-drug we are all waiting for, I bring it up here because it is another pharmaceutical use for silver). A very small amount of silver is also used in most electronic devices including, but not limited to: Cell phones, smartphones, flat panel televisions, tablets, and computers.

These new technologies will drive the demand for silver up for years to come, and will shift the ratio of silver to gold in silver’s favor when compared to historical averages. According to commodity online, the demand for industrial silver is going to increase by 36% (to 665.9 troy ounces) by the year 2015.

The second question that must be considered is whether either of these metals is experiencing a pricing bubble? I have already said that I think silver’s price will continue to increase as industrial demand for it continues to rise. Gold, on the other hand, traded Monday at $1717.70, the highest it has ever traded. The current price of gold has been driven up by pure speculation, as there are no industrial uses for gold. The only two uses for gold are making jewelry and as an investment hedge against volatility. Once the world’s markets become less volatile, gold’s price will fall and will again be in line with historic price trends-- between $450 and $700 per ounce (on the high side) .

Silver is a hedging vehicle for volatility similar to gold, but it also has industrial uses that are creating demand for the metal at never before seen levels. This will drive the price of silver up over the short and long run, and is a great investment for our portfolios.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.