The silver vs. gold debate has strong proponents on either side, but which asset class will outperform? I expect silver to outperform gold under the current U.S. dollar monetary system, but gold will ultimately reclaim its status as the one true monetary king.
Silver vs. Gold:
The investment thesis for both precious metals is exceptionally strong, but to determine which metal will outperform, investors should look at the individual investment thesis of each metal under the current U.S. dollar monetary system; and consider what the monetary system will be post U.S. dollar.
Why The U.S. dollar Monetary System Is Ending:
The U.S. is having a balance sheet recession, which takes much longer to work through than a typical inventory recession, due to the need for massive deleveraging. Corporations' balance sheets are strong again, but the toughest part of the deleveraging process is just starting, as countries must begin the deleveraging process. The United States has drastically overextended itself. As the largest debtor nation in history, the U.S. will never be able to repay its debt in real terms. The world knows this and is moving away from the dollar at an increasing rate. China is reducing its treasury holdings, while the demand for dollars to settle international trade is shrinking. China announced it will start accepting the Yen as settlement, while several countries have agreed to trade with each other outside of the dollar system in their own respective currencies. SCO member nations and observers are accumulating gold in lieu of treasuries. Recently China and India offered to trade Iranian oil directly for gold, bypassing the dollar entirely. The estimated size of the global derivatives market is $1.2 quadrillion dollars (20 times larger than the global economy) which alone guarantees that at best, a massive restructuring of the dollar.
Under The U.S. dollar Monetary System:
Under the current monetary system silver appears to be the clear winner. With only half the above ground supply, and approximately a 1:1 ratio of investment dollars flowing into silver and gold, silver prices should outperform gold. Additionally, silver is much lower relative to its inflation-adjusted high than gold. As countries go through the painful process of deleveraging their own debt-ridden balance sheets, investors will continue to seek alternatives to fiat currencies; and silver will play a major role for many investors. I expect silver to begin trading more like money, and as a result, trade at a significant premium due to its perceived status as a monetary asset when compared to other commodities.
After The U.S. dollar Monetary System:
Silver will trade like money, but it will not become money. Whereas silver's best use is as an industrial metal, gold's best use is as a monetary metal. Silver is used, while gold is accumulated as a store of value. Silver's relatively low value density, susceptibility to tarnish, lower above ground supply, and extreme price volatility favor gold as the future monetary asset. There is only a need for one monetary metal, and gold fits the role of money better than silver. Like other commodities, silver will ultimate trade based on its supply and demand fundamentals (which are exceptionally strong) but with a slight monetary premium.
Several major events paint a clear picture that gold will be the metal entering the monetary system. The formation of the euro was one of the first moves toward a gold based monetary system, with gold being held as a full reserve asset that is marked to market on their balance sheet. Since then we have seen major banks begin accepting gold as collateral, as well as gold being used as settlement of debt for international trade (i.e. China and India buying Iranian oil for gold). Recent news also indicates Basel III may be amended so that gold is reclassified from a Tier III asset (only 50% credit) to a Tier I asset with no discount (same as a treasury bond). Adding additional credence to gold is Germany's proposal to issue gold backed euro bonds. Central banks are accumulating gold, and that is what will be part of the monetary system. Once gold becomes globally accepted as money, its value will increase due to its use as an exchange for other assets. Gold will be the monetary asset of the future because the world is already moving in that direction.
What Will Be The Result For Gold and Silver:
I believe the gold/silver ratio will contract significantly over the next few years as global sovereign debt concerns cause investors to look for a safe haven outside of fiat currencies. Silver will appreciate in price greatly as it begins to trade like a monetary asset, but ultimately gold will be the world's monetary asset, which will result in the gold/silver ratio to skyrocket.
Precious metals investors should own both metals due to the probable near-term outperformance of silver, but the future monetary system favoring gold. Silver bulls should consider the fact that ultimately the future monetary system strongly favors the probability that gold will be the monetary asset, and may want to swap their silver for gold as the gold/silver ratio contracts. Gold bulls looking for leverage on gold might want to consider allocating a portion of their portfolio to silver in an attempt to swap their silver for more gold at a later date. Investors should purchase physical precious metals first, and then focusing on more tradable precious metal investments like the SPDR Gold Shares (GLD) and iShares Silver Trust (SLV).