Historically (1808 – 2008), the ratio between
gold and silver has been 33 ounces of silver equals one ounce of gold. More
recently, say 1978 – 2008, the ratio has widened to on average, 60 ounces of
silver buys one ounce of gold. At the extremes the ratio fell to 17:1 in 1980 as
both metals peaked; and rose to 100:1 in 1991 during the depth of the recession.
During the 1976 – 1980 bull market in
precious metals, the ratio fell from 40:1 to 17:1
During the 1990 – 1991 recession the ratio
rose from 71:1 to 100:1
The latest bull market in silver began in
2003, and from then until mid 2008, the ratio dropped from 80:1 to 45:1.
A few months ago, as more and more people
began to suspect that the world was heading for a recession, the ratio rose
again, from 50:1 to the current 80:1
A LESSON FROM HISTORY.
The clear lesson from history is that we can
expect silver to drop faster than gold during a recession, and silver will rise
faster than gold during a bull market in the metals.
A simple application of this observation is
to trade silver for gold in the middle of a recession, when a bull market in
gold and silver is about to start, and to trade gold for silver at the top of a
bull market in precious metals.
It behooves us to remember that the actual
peaks only last for a few seconds. Though the action will show up as a line on a
chart henceforth forever, the actual amount of any stock or commodity traded at
the precise peak is minimal. Most of the action takes place when traders are
convinced that a top (or bottom), is in place.
It is said that technical analysis works best
when it is based upon fundamental analysis. The fundamentals for gold are very
bullish. Supply is coming from three sources, gold mines, recycling and central
banks. The gold mines are supplying less gold every year, as mines become
depleted and new mines are not coming on stream fast enough.
Mining experts do not expect any large new
gold mines, until the gold price rises above $1,200.00
South Africa’s gold mines, the world’s #2
suppliers, are still suffering from power shortages, and mines there are
delivering about 10% less gold compared to a year ago.
The world’s #1 supplier, China, is reported
to be keeping all the gold mined in China within its borders, to balance its
reserves, which at last report were less than 3% of its huge ‘paper reserves.’
Supply of scrap gold has been rising, along
with the higher price, but that supply is finite.
It will no doubt rise each time there is a
sharp rise in the gold price, but eventually it drops off, as people run out of
rings, bracelets and gold teeth.
The supply of gold from central banks was
predictable at 500 tonnes per year, until the 2007-08 fiscal year, when sales
dropped off noticeably.
The suspected reason for this drop is very
likely the credit crisis, as central bankers realize they need to hold onto gold
to create the illusion that the paper and digital money they have issued is
safe, since they have gold with which to back up all that paper. Never mind that
gold is no longer used for that purpose.
Demand for gold is very strong, especially at
the investment level. Reports of shortages of coins and small bars have come in
from all over the globe. Several Mints have stopped taking orders, and other
mints are working overtime to fill orders. Dealers are paying a premium over
bullion value in order to replace stock they sold earlier.
THE OUTLOOK FOR SILVER.
The picture for silver is even more bullish!
Silver has been in deficit for the last 18 years. The dramatic rise in the price
of silver that ended in 1980 enticed people all over the world to cash in, by
selling old coins, silverware, cutlery as well as silver jewelry purchased over
the years from manufacturers in Mexico, Peru and Italy. (As an aside, a large
portion of silver jewelry, even though it will be marked .925, is actually
silver plated. It pays to buy silver jewelry only after checking it
over with a magnet! That goes for chains and bracelets that are for sale in
‘reputable stores’ as well! Caveat emptor).
It took the world’s economies about 10 years
to convert this 1980’s excess silver back into useful format, and either use it
up, or see it disappear into an investment portfolio, and today it is estimated
that the world ‘consumes’ 1.5 ounces of silver for every 1 ounce the mines are
The majority of silver that is used in
industry, is applied in very small amounts such as cell phones, computers, TV’s,
refrigerators, medical applications, satellites, weapons systems, electrical
wiring applications etc. In the majority of cases this silver is never
THE MAIN DRIVER.
The main driver for the rise in the silver
price between 1976 and 1980, and the concurrent dropping in the ratio, was
investment demand. People were concerned about the dramatic rise in price
inflation they were experiencing.
Ironically history is repeating again! Not
only are we seeing dramatic increases in the price of the foods we eat and the
products we use, but this time we have problems in the banking sector as well.
Since we know that governments fight problems by throwing money at the problem,
we can be sure that inflation is going to be with us for quite a while.
AN ADDED FACTOR.
When we compare the supply vs demand factor
for silver, we need to be aware of the fact that since 1980 we have almost 2
billion consumers who were not in the marketplace in 1980. Most of them live in
India and China, and large numbers among them are moving up into middle class
status. Middle class people all over the world love ‘gadgets’. Gadgets require
silver. It just happens that people in those two countries also have an affinity
for precious metals.
Thus we have confluence of factors on the
demand side of both silver and gold: Investment demand, industrial demand, along
with the fear factor, due to the current credit crisis (which will be with us
for years to come).
THE BLACK SWAN.
Hiding behind some tall weeds is a black
swan. As outlined above, the time to switch from silver to gold is when a bull
market in precious metals is about to start (or to resume after a correction).
Precious metals have corrected since March of 2008, and may well be ready to
resume rising. The black swan is the almost certain fact that a number of
bullion banks, aided by central banks have taken on very large ‘naked short
positions’ in gold, and especially in silver. The fact that we are now
witnessing a dual pricing system in gold and especially in silver, (‘paper
silver a-la-Comex’ versus ‘real silver’ which applies to anyone attempting to
buy physical silver), is a direct result of this blatant manipulation in the
precious metals markets. When this manipulation ends, it will add extra energy
to the bull market.
Just ask yourself this simple question: If a
billionaire (and there are lots of them out there), wanted to buy 1 billion
dollars in gold could he do it?
If the same billionaire wanted to buy 1
billion dollars in physical silver, could he do it?
The answer to both questions is ‘yes’, but
while buying the silver, he would drive the price up by multiples of the current
price. Silver is scarce!
Since 1984 a trading range has developed in
the ratio. With the ratio near 45 it makes sense to trade silver for gold, until
the ratio breaks sharply below 45 and thereby indicates that it is starting a
new trend. With the ratio near 80, and even if it rises back up to 100 it makes
sense to trade gold for silver.
The bull market in precious metals very
likely has not even reached the half-way point in either price or time.
(Gold started in 2001 and silver in 2003). “Real interest rates” are
currently negative (T-bill minus CPI), and gold always thrives in that kind
The credit crisis will be with us for a
number of years and governments will continue to ‘print’ money to ‘solve’
the problem. The US Federal Reserve is currently expanding the Monetary Base
in excess of 20%! Money supply is growing on a global basis. The US budget
deficit this year will be another record.
Investment in the metals is just
beginning to move from ‘stealth’ into main stream. This process takes years,
as people are slow to change investing habits.
The current perception of a recession in
the USA, and the depth thereof, may be overblown, thanks to a biased media.
(Believe it or not, some people in the media will say whatever they feel led
to say, in order to make their favorite party look good, and the party they
want out to look bad). In any event, the slowdown we are experiencing in
North America may not affect Asia very seriously. China’s #1 customer is not
the US, but Japan. As soon as confidence in the world economy returns, we
can expect the ratio to drop again.
The recent rise in the US dollar was
caused by at least two factors: First: hedge funds were unwinding positions
that were short the dollar and long oil. Oil appears to have bottomed at 80,
thus that factor is now ‘in the market’. Second, it was thought that the
Euro (which makes up 57.6% of the US dollar index), was going to be even
more negatively affected by the credit crisis than the dollar. That
condition is now also ‘in the market’, and leaves the dollar vulnerable to a
sell-off. In the past, weakness in the dollar has translated into strength
Silver is now scarcer than gold! This
factor alone makes me steer my investment dollars into silver, rather than
in gold for the time being. My long-term target for the ratio is 10:1, and I
base that on the growing demand for silver as an industrial metal in
combination with silver as an investment, while the supply of silver
continues to dwindle. When I first became interested in silver in the early
1960’s, the US government had a stockpile of 2.5 billion ounces. That silver
is gone, used up! Before the ratio drops again, it could rise above 80, and
could even reach 100 again as it did in 1991. If that happens, I will become
even more convinced that it is time to trade gold for silver.
As I prepared this article, gold at the
Comex was down 17.00, while silver was up .50c; a sign of things to come?
Please do your own due diligence. I am NOT
responsible for your trading decisions.
Peter Degraaf is an on-line stock trader with
over 50 years of investing experience. He issues a Weekend Report on the markets
to his many subscribers. A sample copy of a recent report is available upon
request. Long-term charts are available as a free service at his website
www.pdegraaf.com (Due to time constraints and growing
administrative costs he no longer offers a free trial service).