Before You Buy Silver, Remember The Coinage Act Of 1873

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 |  Includes: AGQ, DBS, DSLV, PSLV, SIVR, SLV, USLV, USV, ZSL
by: Simit Patel

This is a follow up to my article on Grover Cleveland and silver -- if you haven't read that, it will help to do so.

I'll begin this article in much the same way as I started that one, which is with some technical analysis and a declaration of my belief that silver will likely reach triple digits. We are at resistance here and I think the signs are there for a short-term pullback. Nonetheless, I consider it more likely that silver will go to $49 before it goes to $28, so buying at $35 is still a trade I believe is worthwhile and offers a 2:1 reward/risk ratio if a stop loss is placed at $28 and a target of $49 is sought. I'm not sure how long it will take to get back to $49, but I consider 'within 6 months' to be my best guess.

The chart below reflects my analysis of the current price action. I'm looking at the monthly timeframe on the chart below.

click to enlarge

Click to enlarge

But now that I've said some nice things about silver, it's time to pull no punches and reveal the shocking, blasphemous truth: Silver is not money.

I know you've heard the opposite, and have witnessed esteemed silver gurus like David Morgan make a strong case for why silver is money. But before you make any judgment, I'd like to you to remember the Coinage Act of 1873 -- and to think about it relative to the events that transpired when US President Richard Nixon closed the gold window and removed the last vestiges of gold's formal connection to the international monetary system in 1971.

To put it simply, the Coinage Act of 1873 had the effect of de-monetizing silver in the United States. Basically, the United States dropped silver and went to a gold-only standard.

What happened to the price of silver? What happened to the gold/silver ratio?

The price of silver dropped and the gold/silver ratio soared to over 40. The silver lobby then demanded that silver be re-monetized, which would have the effect of making the US Treasury a buyer of silver, and thus boosting the price of silver. The silver lobby got their wish with the Sherman Silver Act. As we discussed in my article on Grover Cleveland and silver, this Act de-stabilized the US monetary system, as the market rushed to sell silver to the US Treasury in exchange for gold that was being taken out of the country. It was Gresham's law playing out in classic form: bad money, silver, was being used to push out good money (gold). Grover Cleveland put an end to the situation by de-monetizing silver.

Now, contrast this with what happened in 1971 after Nixon closed the gold window. Many economists at the time believed that gold would fall in value; after all, if it wasn't officially a part of the monetary system, and if silver fell when it was pushed out of the monetary system, shouldn't gold fall as well?

As history shows us, the de-monetization of gold led to the greatest bull market in gold in modern history, with the market soaring from $35 when the gold window was closed to over $850 by the end of the 70s.

Why? How could this happen?

The answer is simple: gold is money, whether the central banks want to acknowledge it or not. The market has decided this, because gold has all the necessary attributes of money: durability, scarcity, simplicity (ease of recognition), divisibility, portability. And, it has one special characteristic that almost nothing else has: a complete and utter lack of use, outside of psychological value like jewelry. In other words, there is no industrial demand for gold. This leaves it safe to be a recipient of only monetary demand, making it a superior form of money.

There will be those who argue that gold is too scarce. If gold is already near $1800 an ounce, it is unaffordable to many. How can such a pricey commodity be used as money if many cannot afford it? Isn't that where silver comes in?

To address this point we must first consider the two aspects of what money is: (1) a medium of exchange and (2) a store of value. In many ways these two attributes are paradoxical; scarcity is needed to serve as a store of value, but something that is infinitely divisible is needed as a medium of exchange. Historically, we've used paper certificates and digital bits to help make stored value more easily transferred as a medium of exchange. And so, I think digital bits fixed to the value of gold are more likely to serve as the medium of exchange in the economy to come.

Moreover, if silver is really valuable because it is more abundant and thus a better medium of exchange, is there really enough silver to go around? The answer is no. If you divide the amount of silver in the world by the world's adult population, there clearly is not enough silver to go around. See this video from David Morgan for a closer look at the numbers.

Now, silver also has great industrial demand. Solar panels, which rely on silver, have a bit role to play as the sidekick to nuclear power in the world's transition to a new energy paradigm beyond fossil fuels -- and this is in addition to demand from biotechnology, electronics, batteries, and water purification systems, all of which I expect to continue to grow. So once silver clears $50, watch out: there is no resistance at that point, and the market will likely get more volatile than ever.

But, for the reasons outlined in this post, I don't think it's money. And that's an extremely important distinction when determining how much capital you want to allocate. If you're all in on gold, you're all in on real money as the market proceeds to eradicate faulty debt -- on safety, on insurance. If you're all in on silver....you're all in on risk.

Disclosure: I am long physical gold and silver, silver derivative contracts, and gold and silver mining stocks.