Gold vs. Silver, Round 2 - Store of Value vs. Value

Includes: GLD, SLV, ZSL
by: Galt's Gulch

Many people believe that gold stands to gain much more than silver. I don’t believe this to be the case, and it’s not a matter of calculations or math; it’s a matter of definitions and common sense.

Many people confuse store of value with value – there is a huge difference. Let us use the following comparison. Gold is like a bottle, and value is like water. The bottle is worth something, as is the water. Silver’s just a smaller bottle. Both are stores of value which contain value – two separate concepts.

I can agree with many goldbugs that gold is a better store of value (which is the only reason to trade silver for gold). However, that doesn’t make it a better value. For example, let’s take 1000 shares of Hecla Mining (NYSE:HL). Now, knowing that it has gone from $1.00 in 2008-09 to $7.90 as of today, which was the better value? At the end of the day, which object would allow you to buy more real goods on the market?

Similarly, if silver has gone up 9x since 2001, and gold has only gone up 5x, which is the better value? Clearly many things that are better values than gold.

And that leads to the next point : Arbitrage. If I can get just 500,000 ounces of gold, I can control the world silver market at current prices – unless other people decide to bid the price of silver up so that they too can get silver. Therefore, silver’s price must rise until it reaches a fair value against gold – no matter how high that means it must go.

This occurs because gold’s primary value is that it’s a great store of value while other goods (including silver, to some degree) have to compete on the basis of their intrinsic value. Approximately between 1:10x and 1:16x has been the ratio mined out of the earth throughout all of human history. So a gold/silver ratio (GSR) above that implies either a mispricing occurring right now or that silver has become less useful today than it has historically been. As the GSR is currently 42, one of these must be occurring – but which?

Let’s look at an example of how much silver is in your life. Imagine you get sick; you might first look into a silver mirror to see what it looks like. Then, worried, you might check your symptoms online – using a computer screen powered by silver filaments. You may make a call to the doctor with your cell phone, which uses silver. If you go to the hospital, you’ll be driving a car with computers and filaments of silver in it. Once you get to the hospital, the staff may be spraying surfaces with silver solutions to kill bacteria.

Now, do you truly believe that silver is less important today than it was 100 years ago, when there were fewer chemicals to use it, fewer people to need it, no computers, and fewer uses in general? Exactly. Therefore, a mispricing is occurring. Now, if a mispricing is occurring, arbitrageurs will step in to sell gold and buy silver until a proper “price balance” is established. Unfortunately, one can’t establish a balance if the silver stock continues to fall

If we look at silver, we can see that historically it has always been money, like gold. Some say that today silver’s volatility and the stock/flow ratio mean that it cannot become money again. In other words, if we use silver as money, so little silver is left that new silver production would inflate the money supply and cause disruption. This valid point totally misses the bottom line. During a hyperinflation, all real assets have value. Look at Belarus – starting just two weeks ago and continuing this very day, people are buying refrigerators to maintain value. A refrigerator uses energy, loses value when bought, and always depreciates – so why is it a good store of value? Because on a relative basis, it’s better than cash. While gold might be better than silver as a store of value, silver is relatively better than everything else.

In conclusion, anyone who denies the value of silver or believes that gold will rise to and stay at an unprecedented level against silver (say, over 1:100) understands neither arbitrage opportunities nor the silver market is avoiding reality as it exists in Belarus. The facts on the ground state that silver is money regardless. Therefore, buying physical silver remains the best option.

Disclosure: I am long physical silver, GLD puts, and ZSL puts.