Gold vs. Silver: Living the Difference

So you’ve decided that precious metals are a superior investment to paper claims such as stocks, bonds, and fiat money. The next question is, which precious metal is best? The answer will depend on your individual situation: your risk tolerance, investment goals, the amount of money you have to start, and how much (and how often) you plan on buying. This article will examine gold and silver in relation to these particulars.

There are, of course, other precious metals in which you can invest, with platinum and palladium leading the charge. However, throughout history, it has been gold and silver that have been widely recognized as stores of wealth, and they are more certain to keep and increase their value than more exotic precious metals. With that in mind, let us first examine what it is that gives gold and silver their intrinsic value in the first place.

Intrinsic Value

What gives paper money its value? The answer is that it can be traded for goods and services of real value. But why do people accept intrinsically worthless pieces of paper in exchange for their real goods and services? Answer: Because they know they can then trade that paper to someone else for good or services that they want. In essence, what is being said here is that paper money has value because it has value, and that’s not a very satisfying explanation.

Tracing this back to the root, we find that U.S. dollars were originally linked to gold and silver, so that the holder of a paper note could trade it in for its equivalent in precious metals. This is what originally gave paper dollars their value, and when the notes were de-linked from precious metals, people continued to accept them because they were confident that others would continue to accept them. This has worked for 40 years, but it could have never worked if the paper dollars hadn’t originally been linked to something people valued for its own sake. But why do people value gold and silver?

Ornamentation and Monetary Exchange

Throughout history, people have valued gold and silver for their unique properties. Kings and pharaohs have prized them as symbols of wealth and prestige, used in ceremony and ornamentation. It might seem strange to base something as important as the monetary system on jewelry, but it’s important to note that gold and silver emerged as money, organically, on the free market—they weren’t “declared” money by a dictator. All that is necessary for an item to become money in a free market is that people value it for its own sake—it doesn’t matter why they value it. From there, the most liquid goods take on the role of money in a barter economy, and this is what has happened to gold and silver in various places and at various times throughout history. And once goods take on the role of money, they then become even more valuable since they are desired not only for their own sake, but also to be exchanged for other goods.

In modern times, paper has usurped the natural role of gold and silver as money, but it is not hard to imagine a time in the not-too-distant future in which gold and/or silver will re-emerge as exchange commodities. In fact, it is already starting to happen in the black and gray markets of the United States and elsewhere. But irrespective of this, gold and silver have even more value now than they did in the time of the Egyptian Pharaohs and Roman Caesars, as in addition to their ornamental and exchange value, gold and silver are also used in countless industrial and commercial applications.

Practical Applications

Gold has numerous uses beyond jewelry and coinage. Gold is ductile and malleable—it may in fact be the most malleable metal on Earth—and this means it can be drawn into very thin wire. When beaten and rolled into sheets, this is known as gold leaf. Gold is also used in photography, as a toner, but of course this use is ever declining with the advent of digital photography over traditional film. Gold reflects electromagnetic radiation and is used for protective coatings on satellites, and in infrared protection suits for astronauts. Gold is also used in a similar fashion for the EA-B6 Prowler warplane. Additionally, gold is used in medicine, electronics, and commercial chemistry.

However, despite gold’s myriad practical uses, silver truly is the world’s most indispensable metal. It is the most electrically conductive, thermally conductive, and reflective metal on Earth. In addition to its more obvious uses in photography, high-end cutlery, and jewelry, silver is also used in host of industrial and commercial applications. Batteries, hearing aids, RF connectors, printed circuits, computer keyboards, electrical contacts, power cables, mirrors, musical instruments, and a variety of vital chemical compounds all rely on silver. Approximately 77% of silver is used for applications other than jewelry and investments, whereas this is true of only 10% of gold. Thus, it is safe to say that in a head-to-head battle between gold and silver, silver definitely gets the edge in terms of practical demand.

Supply Factors

Throughout history, gold has obviously been the more cherished of the two precious metals, and that continues today. It makes sense that gold would be most prized for its beauty and properties, however, today’s modern uses for silver would indicate that the discrepancy between gold and silver should not be so great, if all other things were equal.

What makes things not-so equal is the differences in the total supply of gold and the total supply of silver. One would think that gold would be the rarer of the two, and at probably any other point in history, this would be correct. However, the increased industrial uses of silver have severely reduced the world’s supply of the metal, whereas virtually 100% of all the gold ever mined in the history of the world is still with us today. Neither gold nor silver can technically be destroyed, but silver is consumed in many industrial uses and commercial products, and ends up embedded in those products in the bottom of landfills. The cost of recovering the silver from the landfills is greater than the cost of mining new silver—for the time being. However, if trends persist, this may not be the case for long.

The U.S. government’s stockpile of silver has fallen from 3.5 billion ounces in 1965 to less than 20 million ounces today—that’s a reduction of 99.9944%. Governments continue to hold some gold, but all of the world’s governments today hold a combined total of less than 0.2% of the silver that U.S. alone once held. As late as 1990, the total known stockpiles of silver were larger than the known stockpiles of gold, but today, silver stockpiles are a tiny fraction of gold’s, and at the current rates of mining, silver will be the first metal to vanish from the face of the Earth! In fact, some analysts predict there will be no more silver in just 25 years. This is very bullish for silver.

Market Manipulation

The gold market has been manipulated by governments and their central banks for centuries. Prior to the U.S. government’s abandonment of the Bretton Woods pseudo-gold standard in 1971, a large “gold pool” worked to keep the market price of gold under $35 an ounce. When they no longer could, President Nixon decided to “close the gold window” and make the dollar a fiat currency, and as a result, gold skyrocketed.

Gold continues to be manipulated today. One way this is done is through the process of “leasing,” which takes place when governments and central banks “lend” gold to mining companies, who have orders for more gold than they’ve mined. The miners then sell this gold as if it were their own, with the promise to repay the government lenders, in gold, at some future date. The problem here is that these loans are often unreported, and as a result, supply numbers are inflated. The governments and central banks keep their leased gold on their books, and thus the world’s supply of gold is overstated.

Goldbugs always said that when the gold-leasing bubble popped, gold would soar, and this is probably one of the major factors that sent gold from $200 an ounce to a recent high of $1,500. However, the fact here is that the story has probably already played out: the central banks have likely run out of gold to lease, and this is one of the main reasons gold has been so bullish over the past several years. Now, this does not mean that the future outlook for gold is bearish, and in fact, the inability of governments to continue leasing will restrain them from holding gold back, but the big “pop” gold fans expected has probably already happened.

Silver, on the other hand, continues to be heavily manipulated. A tiny cabal of four or fewer short sellers have been keeping the price of silver down for years. These short sellers have contracts equal to double the world’s known supply of silver, but when the contracts expire, they don’t deliver the silver—which in all likelihood doesn’t exist—but instead, they buy new short contracts, rolling over their positions, and taking major losses in the process.

Since this has been going on for years, it leads to the question: Who could afford to repeatedly take these losses over time? Only someone who literally has the keys to a printing press—namely the Federal Reserve, the U.S. government, or perhaps a consortium of governments, who absorb the losses by expanding the money supply. Private funds, no matter how large, would probably not be able to sustain these losses, and even if they could, to what end would they be playing this game? Governments always want to manipulate the precious metals markets because highly priced precious metals reveal the weakness of their fiat currencies. The world’s states lost control of gold, for the most part, which is why it has been skyrocketing over the past several years. Silver, on the other hand, has been kept in check until recently. With the price threatening to hit a new all-time high, perhaps these short sellers will take their final lumps and fail to renew their positions—and this would result in an absolute explosion in the per-ounce price of silver.

Recent Performance and Current Valuation

Since the beginning of 2007, gold has gone from $700 per ounce to as high as $1,500, closing at $1,496.20 on April 19, 2011—a 114% gain in approximately four years. Silver, on the other hand, has gone from $10 per ounce at the start of 2009, to as high as $43—a 330% gain in just over two years. As recently as September 2010, silver was valued at less than $20 per ounce, and while gold is routinely hitting new all-time highs, silver has still yet to reach its nominal high of $50.35, which it hit back in 1980.

Given gold’s current market value at $1,496.20 per ounce, and silver’s at $44.02, one ounce of gold is valued at 34 ounces of silver. Not that long ago, this ratio was in the 60s and 70s, and thus silver has been surging when compared to gold. However, the historic relationship between the two metals is closer to 15-to-1, which means that silver should more than double in relation to gold—and if gold continues to go higher, as it should, than silver will just have to go that much higher still.

What’s more, whenever one commodity is drastically overvalued in relation to another, as has been the case in terms of gold compared to silver, the natural reaction of the market is to “overcorrect” when the pendulum swings back in the other direction. In other words, instead of gold declining from 34 times the value of silver to 15 times, it could “overcorrect” to 12 or even 10 times—maybe even 7 or 5 times. But even assuming that gold kept its current valuation and silver only reached 1/15 gold’s price, that would still put silver at just under $100 per ounce, which is a very reasonable target.

Purchase and Storage

Here is another category in which silver tends to have the advantage over gold. Given gold’s current valuation, buying even a one-ounce gold coin is expensive. This is not a “problem,” per se, because the gold is worth what you’re paying. But if you’re a man or woman of more modest means, it may require some diligent saving just to purchase one ounce of gold, and while you’re saving, the price of gold could go up and the value of your saved dollars could go down. By contrast, buying a single silver coin is easy, and you can currently buy a tube of 30 of them for right around the same price as one gold coin.

However, if you have already accumulated savings, or you are converting sizeable assets into precious metals, gold can be preferable due to its vastly superior value density. Around one million dollars worth of gold could be easy contained in the space of a shoebox, whereas that much silver would require considerably more storage space. For most investors, however, this is not a realistic concern, as silver is incredibly value-dense as well, especially given its recent appreciation.

Risk Tolerance

It would seem that gold is the “safer” of the two investments, as it has historically been far less volatile. Gold hit a high of $850 in 1980 and has just recently doubled that. Silver, by contrast, exceeded $50 per ounce in 1980 and was trading at less than $5 per ounce by 1991. However, one could make the argument that, given their historic relationship, gold is the “riskier” of the two investments, in that it is still valued at 34 times silver, whereas the traditional ratio between the two is closer to 15-to-1. Furthermore, the fact that gold is at twice its nominal high could indicate that it is overvalued, whereas silver is still below its nominal high and well-off its CPI-adjusted high.

Conclusion

Given its status as the more practically useful, the rarer, the more manipulated, and the more historically undervalued of the two, silver would appear to be the superior investment for most individuals. However, the more money one has to invest, the greater mix of gold one should consider. Investors with $1 million or more may prefer the presumably safer, more reliable gold, especially because it can be stored using far less space. Someone with $100,000 or more may prefer a mix of gold and silver, whereas someone starting with nothing and just devoting a portion of their weekly pay to buying metals would be better off concentrating on silver. No matter your starting wealth or investment profile, everyone would be well-served to begin devoting at least a portion of each paycheck to the accumulation of gold and/or silver bullion.