Is Silver Money?

 |  Includes: AGQ, GOLD, SLV
by: Bruce Pile

Gold is a metal that is garnering some attention these days as the "alternative currency" while the world seems bent on debasing all other currency. Historically, that has been gold's main utility, whether you show it off as a necklace or put it in a bank - it has been money down through the ages. But what about silver? We haven't made coins out of it for decades. It's commonly referred to as "the poor man's gold" and gold's ugly cousin and other derogatory phrases. And since the age of electronics has set in, 90% of it is used for such inglorious things as connections in our gizmos, which wind up at the bottom of our landfills.

It wasn't always like this for silver. The Greeks honored silver 2500 years ago by making it into coins, and, in fact for the next 2400 years, silver was the main means of exchange in daily commerce. Gold was used mainly just for big international trade or money actions between banks. As Milton Friedman once noted. "The major monetary metal in history is silver, not gold." It was 30 pieces of silver that betrayed Christ. If you look at the Bible or any old writings where the monetary metal pair is mentioned, it is typically "silver and gold" - not as we say today "gold and silver". It was today's ugly cousin who was the belle of the ball back then.

Is there any reason why silver, or gold, was viewed as money? Well, both metals are very rare. There are the so called "rare earth" elements, but they are actually quite abundant compared to gold and silver - just not as abundant as the base metals. So the monetary pair was given the status of the basis of exchange and the value ratio between them was set at around 15 - the gold/silver ratio (GSR). This ratio has become the subject of a lot of investor interest in our time as we try to value precious metals. There is geologic reason for the GSR being around 15 -17. Silver is 17 times more abundant in the earth's crust than gold on a parts per million basis.

The first few Congressional coinage acts in America specifically set the gold/silver ratio at various numbers around 15. And even the Greeks set their ratios in the low teens. Governments have gone back and forth between silver and gold or both (bimetallism) as to what they set official money supply by. It turned out to be a complicated mess with both metals legal tender. When one metal price rose above the other, coins were melted down. But all money, especially the silver backed common exchange pieces, remained metal backed.

Then during the Civil War, Lincoln issued Greenbacks without metal backing to temporarily finance the war effort - our first paper money and our first adventure into fiat money. This instigated the "free silver" movement where the vast new silver finds in and around Nevada, were argued as sound money expansion of the money supply. "16 to 1" became a hot political slogan of "the silver ticket." We endured this bimetallism approach to money with various coinage acts of Congress for most of our history. It was just from 1900 to 1971 that we were on an official gold standard. In the U.S. of the late 1800s the rural farming population with a lot of debt and nagging deflation wanted bimetallism, a big debate of the day and the big issue in the 1896 presidential election.

The free silver rebels wanted both metals as money supply, the more ounces the better - a kind of early easy money policy, but all metal backed. It's been rumored that this debate was reflected in L. Frank Baum's "Wizard of Oz" originally published in 1900. The yellow brick road (NASDAQ:GOLD) was originally traversed with Dorothy's silver slippers, later changed to ruby red. The "Oz" is thought to be a reference "ounce." But bimetallism, with all its complications, faded to a Congress mandated gold standard in 1900. Money supply was, however, expanded per the cries of the silver supporters with the issue of silver certificates backed by silver from 1878 to 1964 to circulate alongside the gold-backed notes. But a movement away from the historical "silver as money" paradigm had begun. This really started us on a road past Dorothy's scarecrow of loose money that has strayed away from pure metal money to disruptive bouts with other types of money. Not long after the gold standard decree of 1900, we had currency mayhem. The Panic of 1907 resulted in the creation of the Fed in 1913 and, well, the rest is history :

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This long-view chart shows what has happened to the gold/silver ratio since those days. It's basically been a story of the alternating periods in history where either paper was viewed as money or metals and hard assets in general were viewed as money. Wars, for whatever reasons, seem to bring the money view back to monetary metal and wind up putting the GSR back at 15. But disenchantment with paper bubbles sure seem to do the trick every time as the chart shows in the aftermath of 1929 and 1999. When we got away from making coins out of silver in the 1960s, we also ended the silver redemption of our bills that had "silver certificate" printed on them. Currency mayhem soon followed. It seemed like inflation was an unstoppable force ending the world as we knew it in 1980.

During the last portion of the great gold bull market of the 1970s, when metal again came to be viewed as money, there was a swift return to 16 to 1 on the chart. Silver has the tendency to lag the big moves in gold, then do a very swift catch-up move. This seems to be playing out now with our current gold market:

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The red line is the gold/silver ratio, and it amazingly heads straight to the ancient 16 to 1 as the investor view is turned up to maximum "metal as money." If this happens yet again, it would put silver at $125 if gold were to go to $2000. That is a much leveraged gain on an increase in gold. But if the gold bull market sends gold ultimately to $10,000 and beyond as many predict, a return to the historic monetary metal ratio would put silver over $600.

But could we really drive silver to such outdated monetary levels? Consider that only 10% of the stuff goes to the investment market, and we are off any gold or silver standard now. Well, that was the case in 1980 and it didn't keep "16 to 1" from rearing its barbaric head. If you are wondering if we really equate silver with money nowadays, you need not look any further than an R-squared analysis between gold and silver prices of the last few years. Gold is clearly the money metal, and silver, despite having vastly different practical use fundamentals than gold, trades in near lockstep with gold with R-squared values around 0.96 (1.00 is a perfect correlation). Gold doesn't correlate this way with copper, sugar or anything else. Adrian Douglas has an excellent article at where he plots silver and gold prices from the last 6 years. He derives an equation just from the plots with the gold price as input and the silver price calculated solely from the gold price. He then plots a "synthetic" silver price (from the equation) and overlays this with the actual price chart for silver - the two graphs are nearly identical. He concludes that big money interests determine both the gold price and silver price. They view both as money nowadays.

Is silver money? History seems to say it was and is and will be the most basic money. We may be missing a passage in the Bible that reads, "Thou shalt be smitten with great calamity as thy path strays far from 16 to 1." In a world where all currencies are being debased, questioned, and abandoned, what if I told you there was a money that has been present and stable since the beginning of wealth, and that will give you 8 times the gain of gold as people flock to it? Silver may be just that.

If you're not a futures trader, how do you best take advantage of a possible silver boom coming? There is the most popular ETF, the SLV (the silver version of gold's GLD) or Silver Wheaton, the biggest silver mining royalty company (the silver version of gold's RGLD). But the thing that offers the most leverage to any silver explosion (both down and up) is ProShares Ultra Silver AGQ. This ETF does not claim to hold any silver for you, as GLD does with gold. You don't have to trust it for that. It is a two times leverage product, but during big climbs, it has actually done quite a bit better than two times the return of silver. Other than the benefits of backwardation in the silver futures, which the ETF rolls each month, I really don't know how it pulls off this massive outperformance in silver shortage/up cycles.

If you do a performance comparison at Yahoo Finance or a similar site and put AGQ alongside SLV and the Dow since AGQ's inception in early '09, you cover the silver collapse of May, 2011, and AGQ still far out-paces the silver price. And they both leave the Dow behind in their dust with triple-digit returns. During the strong up phase in silver from October 2010 to the high in May 2011, SLV returned about +110% while AGQ returned about +320%. That's roughly 2.9X leverage - much better than the advertised 2X. If we have an equivalent or better climb in the precious metals ahead, AGQ is a prime consideration for leveraging it.

Disclosure: I am long SLW, AGQ, SLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.