Opinion Gold and Silver: The Historical Relationship and What it Means to Today’s...

Gold and Silver: The Historical Relationship and What it Means to Today’s Investors

For most of the nineteenth century, it was decreed — by fiat — that 15.5 ounces of silver were equal to one ounce of gold. According to Congressman Ron Paul and other like-minded monetary theorists, this artificial pegging of silver to gold is what created the depressions and panics of the bi-metallic era. To disciples of the Austrian school of economics, a single monetary base — normally gold — must be the basis of money, and the fiat decree of a silver-to-gold ratio is almost as bad as fiat money itself!

But this 15.5:1 ratio is still with us to this day. Why is it so persistent? Could it be that there is some validity to the historical ratio? Since the current ratio is fifty-two ounces of silver for every one ounce of gold, a supply-and-demand driven return to the historical 15.5:1 ratio — or anything near it — would signal a massive bull market in silver, a huge crash in the value of gold, or a little of both.

Gold and Silver in the Twentieth Century

The fixed exchange rate between gold and silver had largely been abolished by the start of the twentieth century. By 1910, it took 38.28 ounces of silver to buy one ounce of gold. By 1930, the silver-to-gold ratio was 63:1. Ten years later, it took 98.57 ounces of silver to buy one ounce of gold. Then, throughout the fifties and sixties, silver began to appreciate relative to gold, and by 1970, the silver-to-gold ratio was 23:1. Shortly thereafter, the price of silver went on a roller-coaster ride as the Hunt Brothers cornered the market, and in the aftermath of that episode, the ratio swung wildly in the other direction, reaching 102:1 by 1990.

The average silver-to-gold ratio over the entirety of the twentieth century was 47:1 — a far cry from the 15.5:1 ratio of the nineteenth century. Today gold is even more valuable, relative to silver, with the ratio currently standing at 52:1. Even a return to the 47:1 ratio would indicate a mini-rally in silver (or a mini-crash in gold), but is there any reason to expect such a return? Or, going further, is it possible the silver-to-gold ratio could ever approach 15.5:1 again?

Israel Friedman certainly thinks so. “The rarer and more industrially needed item should be $650 and the more plentiful and less used item should be $13.” Although he may be a bit hyperbolic, Mr. Friedman and others like him argue that the silver-to-gold ratio today should be at historic lows — not just 16:1, but perhaps 1:16 or 1:52!

Non-Monetary Ratio Measurements

There is other evidence to support a bullish silver hypothesis. The silver-to-gold ratio, in terms of the volume of ounces traded in the commodity markets, is approximately 7:1. When viewed from the perspective of COMEX inventories, the ratio is roughly 12:1. According to the U.S. Geological Survey, the known world reserves of silver are 270,000 tons with a reserve base of 570,000 tons, compared to 42,000 and 90,000 tons, respectively, of gold — thus providing a 6.43:1 reserve ratio and a 6.33:1 reserve-base ratio.

Global production is another way to compare silver to gold. Recent global production statistics place the ratio at around 8:1, which is historically low for silver, meaning it is rarer than usual, relative to gold. For example, in 1910, the global production ratio was 10:1, whereas the monetary ratio was 38:1 — a difference of 380%. If the same difference held up with today’s global production ratio of 8:1, the monetary ratio would be 30:1 instead of 52:1 — meaning silver would be worth 173% more than it is today.

Of course, there’s no real reason why there should be a 380% difference between the global production ratio and the monetary ratio. For many years, the monetary ratio has been out of whack with almost all other measures, and many silver bulls think the gold/silver relationship is long overdue for a major correction.

What This Means for Today’s Investors

If the silver-to-gold ratio were to revert back to 15.5:1, would this necessarily mean a bull run in silver? Couldn’t it mean a huge crash in the price of gold? While technically, the answer is yes, practically speaking, there is virtually no chance that gold could fall far enough to meet the 15.5:1 ratio without a major bull run in silver. Think about it: If silver were to stay around $13 an ounce, this would mean that gold would have to fall all the way to $200 — a 70% decline! Yes, gold has declined by this much in the past, but that was coming out of an era of double-digit inflation. With the Consumer Price Index around 3% and the government as fiscally reckless as ever, the idea of a crash in gold the likes of which was seen in the eighties is highly improbable.

The fact of the matter is the silver-to-gold ratio is at historic highs at a time when it should be near historic lows. This is not a bearish indicator for gold, but a strongly bullish sign for silver. Even if gold were to fall by 20%, and even if silver assumed a 20:1 ratio instead of 15.5:1, this would still mean silver priced at $26.80 an ounce — double current price of silver.

When it comes to silver, though, not working may represent a double. Working could mean a return to the 15.5:1 silver-to-gold ratio without a decline in the price of gold. And really working could mean that Israel Friedman’s prediction comes true: silver surpasses gold as the more valuable metal, inverting the ratio and making millionaires and billionaires out of thousands of silver-bugs. Stranger things have certainly happened in the history of silver, the notoriously volatile cousin of the comparatively stable gold. For this reason, putting 10% in silver may indeed prove to be a wise financial decision.

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