Gold/Silver Ratio – the Big Debate

Not everybody is aware that there is a big debate among precious metal investors regarding the importance of silver to protect from the dollar’s demise. We have a similar debate that is better known when it comes to precious metals versus Bitcoin and other virtual currencies.
Many precious metal investors disregard Bitcoin as a proper mean to store wealth and protect from currency crises while at the same time many in the Bitcoin community are not interested in investing in precious metals.
Indeed, I’ve asked that question of who was invested in gold and silver at a recent Bitcoin event and I was somewhat surprised at how few hands raised up.
But this debate among precious metal investors is not known by many and I’d like to bring it up here and at the same time tell you why I personally favor silver over gold, although I think both should be owned in this current environment of dying paper.
Precious metal investors might be grouped in 3 camps:

 

Submitted by Phil Champagne:

  • Gold only (believes silver is not a good investment)
  • Gold and silver (both equally)
  • Mostly silver (either silver only or heavily more in silver)

 

I’m in the last category, although I don’t intend to stay there forever.

 

Right now, the gold/silver ratio is about 63 to 1, with silver at about $18.50/oz and gold at $1220/oz.  The gold only camp claims that the gold/silver ratio will stay that high or even that it will climb up even higher, in other words, that gold’s value compared to silver will keep going up. I’ve even heard from some in the gold only camp that it will go to 1000 to 1 when the dollar will show signs of trouble.

 

In this article, I’ll go over the major points on why I believe the gold only camp is mistaken and why you should at the very least, consider investing in silver as well as gold.

 

When drastic inflation will start to rise above the deck of the Titanic dollar, the man in the street will jump on anything that floats rather than sink with the dollar. Gold will go up and silver, being cheaper and the “poor man’s gold”, will be the other metal of choice as it always has been. After all, the word for silver in 23 languages is the same as “money”. For example, in French, “argent” is the word used for both silver and money, and when I have a conversation in French with my wife related to silver, I often use the English word “silver” rather than “argent” so she knows I’m talking about the metal rather than money. Yes, we speak French, English and Frenglish fluently.

 

Let’s start first with a little bit of science. Looking at the periodic table recopied below, you will notice that copper, silver and gold are part of group 11. Look at the interesting comment stated in the Wikipedia entry about this specific group:

 

Although at various times societies have used other metals in coinage including aluminiumleadnickelstainless steeltin, and zinc, the name coinage metals is used to highlight the special physio-chemical properties that make this series of metals uniquely well suited for monetary purposes. These properties include ease of identification, resistance to tarnish, extreme difficulty in counterfeiting, durability, fungibility and a reliable store of value unmatched by any other metals known.

 

Indeed they are. Gold, silver and to some extend copper have been used as money for several thousands of years and it is only in the recent decades in human history that we went away from them. One fan of Krugman might say it’s natural since now we are a “modern society” or “this time it’s different”, but that would be a mistake to trust your favorite politician with something as important as money. But let’s continue. Group 11 is circled in blue in the periodic table below with Cu representing copper, Ag representing silver and Au representing gold.

atomic table

As the atomic number increases, so does the density of the respective metal. A one ounce coin of gold is much smaller than a one ounce coin of silver. Another interesting connection with the periodic table is the rarity grows as the atomic number increases. In the earth’s crust, there is about 15 times more silver than there is gold. There is also 800 times more copper than there is silver, and equivalently about 15,000 times more copper than gold.

 

Of all metals, silver has the highest thermal conductivity as well as being the most conductive of electricity. Not only that, silver also has multiple medical use for its bio-active properties. In fact, sailors kept silver coins in the barrel of water to keep the water safe to drink. As such, silver has multiple industrial applications, and growing! Silver is the metal the most often referenced in US patents.

 

Now, that information alone is certainly not sufficient in itself to convince anyone that it is worth investing in it. To make it an attractive investment, it would have to be clear that the item is either currently underpriced or that its demand is about to surpass its supply or even better: both. And that’s what I’m about to prove to you, silver’s situation and condition shows it is both undervalued and the demand higher than supply with a deficit only expected to grow.

 

I did claim earlier that I believe the investment demand will only grow as inflation will show its ugly head to the general public. What is not known is that there is less silver above ground than there is gold above ground. Most of the silver is stuck in refrigerators (tiny amount), or cell phones, that only a very high price would make it cost effective to recycle the silver before throwing the old device in the dump.

 

The first clue I’d like to share with you is this: 75% of all silver mining comes as a by-product of other metals. This means most of the silver comes from copper or zinc or gold mining companies. If silver was more expensive, you would expect to see more mines primarily focusing on silver. This would be an indication that silver is too cheap for silver specific mining to be profitable, but again in itself, this fact might not be enough to convince you, and there are more interesting things to share as well.

 

Ratios of Gold, Silver, Copper and other metals

I want to provide this table below as exhibit A.

gold silver copper

This table shows all the metals of group 11 along with other metals. The 2nd column gives the amount in the earth’s crust in parts per million while the 3rd column is a ratio comparing the respective quantity of that metal in the earth’s crust compared to gold. We see that according to this, there is 18 times more silver than gold in the crust while we have 15,000 times more copper than gold. Although silver is 18 times more abundant than gold, it’s 64 times cheaper than gold while being mined just 8 times more than gold. (Note that this gold/silver ratio in the ground of 18 to 1 actually varies depending on the source, with some as low as 12 to 1).

 

Before we continue with the other metals, we need to address an important question. Whether a metal is abundant or not in the crust has nothing to do with its value as an industrial metal, jewelry or investment. So for all those metals such as zinc, nickel and copper, their value is as much tied to their characteristics as well as the availability of other competing material for their respective purpose.

 

Copper (Cu), nickel (Ni) and zinc (Zn) are next to each other in the periodic table and so it might not come as a surprise that the earth’s crust has about the same amount of each. Their price and production rate however varies greatly which is heavily based on their characteristics. The price for the industrial metal will depend on their demand and supply. The supply side will heavily depend on how abundant they are and how cheap is their smelting process. For example, of all 3, nickel is the most expensive per pound while at the same time the least mined.

 

The reason I’ve included the other metals is to demonstrate one point: of all the metals listed, silver is the only one with the ratio to gold for parts per million (18) being lower than the price ratio to gold (64). And it is lower by a factor of 3.5! All other metals have a PPM ratio equal or much higher than their price ratio to gold by a factor varying from about 1 (for Zinc and platinum) to as high as 9 (nickel). For platinum and zinc, their price ratio to gold matches their abundance ratio in the earth’s crust. In other words, silver is being priced as if it was at least 3.5 times more abundant in the earth’s crust than it actually is.

 

Considering both gold and silver have been seen as investment metal, isn’t that surprising to you that the metal that has the highest thermal and electric conductivity of all happens to be mined just 8 times more than gold when there are about 16 to 18 times more of it than gold in the ground? And let’s not forget that the majority of the extraction of silver comes as a by-product of those mines. If this was the only proof I had to offer and if silver was purely an industrial metal like the others, it might still not be enough to convince that jury.

 

Exhibit B

You might say: “well, that’s because copper is very much used for cables and so on”. Indeed it is. But here I bring exhibit B as another argument in favor of silver. The gold/silver price ratio has always been around 15 to 1 throughout human times all the way until we had the silver standard. That only changed in the late 19th century when world governments decided to move away from silver and only use gold to balance trade deficit between countries. Silver was demonetized with the coinage act of 1873 and this lead to subsequent debates that took a center stage in the Presidential election of 1896. In fact, some are stipulating that the Wizard of Oz (Oz for ounces) written in 1900 by L. Frank Baum was inspired on this current event at the time. After all, Dorothy was wearing silver shoes on the golden bricks road (they used ruby shoes in the movie to feature the advent of color in movies).

Source: http://www.marketoracle.co.uk/images/2011/Sep/silver-7_image002.jpg

 

I’m bringing this history since it relates heavily on the supply side of the equation. Countries had heavy stock pile of silver and gold, and now that silver was no longer use in trade balance, governments were dumping it on the market, plunging the price ratio from its historical 15 to 1 to a mere 60 to 1 and sometimes 100 to 1. This brought joy to companies like Kodak, DuPont and Dow Chemicals who were then starting to make more use of the metal and still are. It was also eventually beneficial to electronics; after all, silver is the most conductive of all metals. Only briefly in 1980 that we saw this ratio approaching the long term historic, just to climb back up again. On that subject, if you are about to blame the Hunt Brothers for this, I recommend to read this interesting article from Mike Maloney:

http://wealthcycles.com/features/the-hunt-brothers-capped-the-price-of-gold-not-50-silver

 

This ratio of 60 to 1 or more is about to crash down however. This artificially lower price for silver has been affecting the supply from mining which has been compensated with the government stock piles for those decades. A large depleting stockpile would put pressure on the price which in turn would explain why so few primary silver miners exist. But if a price is artificially lowered by a supply compensated by a stockpile, it is only a matter of time before said stockpile gets depleted. And so they did.

 

Exhibit C

Presenting exhibit C:

http://about.ag/StrategicStockpile.htm

 

The US government stock pile of silver has vanished in 2002, and since then, the price of silver has steadily climbed. We are about to witness the market forcing this ratio back to its normal historical value of about 15 to 1. Prepare for the fireworks. As usual, markets always exaggerate on the other way before stabilizing, so do not be surprise to see a gold silver ratio in the single digit for a short period of time!

The reason why the gold/silver ratio has been so high for the past 100 years is precisely because it was maintained with the supply from government stockpile. In fact, the US government had 14,000 tons of it to spare during WW II; they used it for its electric property as part of the Manhattan project for the electromagnetic isotope separation:

 

Marshall and Nichols discovered that the electromagnetic isotope separation process would require 5,000 tons of copper, which was in desperately short supply. However, silver could be substituted, in an 11:10 ratio.

 

On 3 August 1942, Nichols met with Under Secretary of the Treasury Daniel W. Bell and asked for the transfer of 6,000 tons of silver bullion from the West Point Depository. “Young man,” Bell told him, “you may think of silver in tons but the Treasury will always think of silver in troy ounces!”[130] Eventually, 14,700 tons were used.[131]

http://en.wikipedia.org/wiki/Manhattan_Project

 

So there you have it. There was a silver stockpile back then, and hilariously, the government had so much of silver that it came to the rescue of this project as copper was in high demand during the war. They could use part of the silver supply for this purpose. With a stockpile, it was easy to see why this high gold silver ratio of 60 to 1 was maintained. But now that the stockpiles are gone (as a result of maintaining such high ratio), so is about to vanish this high gold silver ratio.  If a 60 to 1 gold silver ratio was truly justified as the gold-only folks are claiming, I’d like to ask them why then has the silver stockpile vanished? And isn’t that curious that the price of silver has started to go up since the government stockpile has been depleted?

 

Mining is somewhat similar to picking up apples in an orchard when it comes to low hanging fruits. The most costly apples to pick up are those at the top of the tree while those in the low branches are easy grab. Our ancestors have all picked up the low hanging fruits and now, we are left to dig several miles deep in open pit mining to get to the gold and silver as this illustration shows.

 

 

In conclusion, we have covered the very special properties of silver as well as that of group 11 in the periodic table. We have also illustrated the peculiar upside down ratio that silver seems to have in relation to gold that no other metals seems to have. Meaning, with the exception of silver, ALL those industrial metals have a pricing ratio to gold that at least matches their abundance ratio to gold in the earth’s crust. Are we to really believe that silver has the least interesting characteristics of all the metals listed before? That would be a strange statement to make consider it is the most conductive of all metals of the periodic table. And finally, the “emergency government stockpile” has been depleted and since then, the price of silver has started to rise.

 

Whatever increased factor in the price of gold we will observe in the coming years, expect an additional factor of 4 or even more for silver. This will only accelerate when the market realize this outdated 100 years old gold/silver ratio is no longer applicable now that government stockpiles have been completely depleted. To balance this production deficit, several new mines primarily dedicated to silver will have to open and operate in order to increase the production of silver of which currently, let me remind you, 75% comes as a by-product of other metals. As the table illustrated, as opposed to silver, these other metals – that has silver as a by-product – happens to have a higher abundance to price ratio relationship with gold. Mr. and Mrs. the jury, I rest my case.

 

Happy investing!

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