Gold And Silver Ratio

August 29, 2013

The Gold/Silver ratio is currently just under 58:1. Many have cited that the Gold/Silver ratio should be roughly 16:1. This was an historic level that existed largely prior to 1900 during periods when both gold and silver were routinely fixed prices. The ratio as a result was largely fixed as well. That was then but this is now. Since 1900, the Gold/Silver ratio has been far more volatile ranging as high as 100 to as low as 16/17 at the time of both gold and silver’s peak in January 1980. The ratio peaked once again over 100 in 1991 and since then has been on a downward trajectory hitting a low of 32 at the time of silver’s peak at $49.50 in late April 2011.

                                                                                Charts created using Omega TradeStation 2000i.  Chart data supplied by Dial Data

There are numerous arguments in the gold/silver community as to where the ratio should be. There are those that believe that ratio should go back to its historical level near 16. At today’s prices with gold at $1,400 silver would need to be about $90. According to studies silver is almost 19 times more abundant then gold. That would still put silver’s price close to $75. Finally, there are studies showing that the occurrence of silver in the ground is estimated at nine ounces of silver to one ounce of gold implying a silver price of $155. All of that gives off quite a range.

Given lower historical ratios it does seem baffling that the gold/silver ratio is today around 58 which is nowhere near the 9 to 19 range as suggested historically and in nature. The historical lower ratio suggests that buying silver today should be favoured over buying gold assuming a reversion to the mean.

Surprisingly investment grade silver is rarer than gold. If investment demand were to rise for silver it could imply that the price of silver could soar compared to gold. Historically both gold and silver have not only intrinsic value but currency value as well. When investors flee to safety as was suggested with a potential for a military strike on Syria it is gold that is mentioned in the media and rarely silver. Silver, unlike gold seems to not be considered as a safe haven as is gold. Silver has considerable more industrial uses and unlike gold silver is used up whereas the supplies of gold remains largely above ground.            

In 2011, global gold production was 2,618 tonnes. Global silver production was 23,688 tonnes. This fits nicely with the 9 to 1 silver to gold ratio that supposedly occurs in nature. Central banks, however, prefer to hold gold to silver. Annual demand supply deficits can vary but in 2011, silver had a demand supply deficit of 8,678 tonnes vs. 1,668 tonnes for gold. That is a ratio of 5 to 1. However, there is little to imply that the gold/silver ratio should be dependent on demand supply levels.

Debt growth and quantitative easing (QE) have become a consistent characteristic of the western economies – Japan, the US and the Euro Zone. Japan has a government public debt to GDP ratio of 212, the US has a public debt to GDP ratio of 74 while the Euro zone’s public debt to GDP ratio is 90 (all 2012 estimates). For the US all Federal government debt to GDP ratio is now around 102. Debt to GDP ratios at, near or over 100 subtract at least 1% annual GDP growth. Japan’s debt is so unsustainable that a rise in interest rates to 3% could cause the interest alone on the Japanese debt to consume 100% of their budget.

The US’s Federal Reserve is purchasing $85 billion a month or $1.02 trillion annually for its QE program. Japan is purchasing $1.4 trillion of bonds annually as a part of its QE program. As a percentage of Japan’s economy it is large when compared to the US. Annual production of gold and silver at $1,400 and $22 respectively totals only about $135 billion. Two major western economies are pumping roughly 17 times more fiat currency into the market every year then is produced in gold and silver.

The US monetary base continues to grow. The US monetary base has now grown to $3.4 trillion from $875 billion just prior to the financial crisis meltdown of 2008. No wonder there is talk of the “taper” as this growth is not only unsustainable the longer it is allowed to go on the higher the potential for another financial crisis. This dilemma fits well the “damned if they do” and “damned if they don’t” when it comes to continuing the current QE program.

Against this background it was naturally baffling the sell-off for both gold and silver from April to June 2013. The claim was that gold and silver were both overvalued. Against the backdrop of global monetary and debt growth the argument should be that instead they are quite undervalued.

Citibank has come out with a forecast of $3,500 for gold over the next few years. They believe that gold’s price rise should be driven by the ongoing easy monetary policies of the western economies of the US, Japan and the Euro zone. That and the growing mountain of debt in those countries coupled with strong demand for both gold and silver especially from the East (Asia).

Against this background, silver should outperform gold. If silver prices were to revert to their long-term potential of roughly 16 to 1 then with gold at $3,500 silver could rise to $220. That’s a long way from today’s price of $24 for silver.

Source: Measuring Worth – based on annual averages of the daily London PM fix from Kitco – Also seen at Seeking Alpha 324 Years of the Gold Silver Ratio and $195 Silver.

Copyright 2013 All Rights Reserved David Chapman

A gold nugget can be worth three to four times the value of the gold it contains because they are so rare.