In today’s Exponential Investor:
- Holding physical silver long term isn’t all it’s cracked up to be
- Bimetallic ratios have failed. Repeatedly.
- Money reflects society, it’s not a fixed rule
After almost 14 years in the gold business, I have learnt one thing: gold investors are a passionate lot, but my goodness you don’t mess with silver supporters.
I was reminded of this just recently at a private “silver stacking” event.
To the uninitiated, silver stacking is popular among zealous fans of the metal, the kind that opt for dogma over facts.
Silver stackers have a private forum, and get together throughout the year to swap their silver and catch up. You’d be amazed at the variety of silver available. If you’re a collector, these events are a great way to pick up unusual, or no-longer-minted pieces.
However, among most forum participants there’s one view that more or less prevails.
I’ve shared this view many a times over the years, and it never lands well… so here goes. I’ve shared this view many times over the years, and it never lands well, so here goes: too many silver fans believe silver is undervalued, and that there will be a reversion to an historical average…
Dogma over facts
I was caught out in last week’s podcast. I mentioned my views on the gold-to-silver ratio and said I’d provide a link to in the email to explain what I meant in more detail.
Well, whoops, I hadn’t written anything for Exponential Investor on the subject.
Today, let’s tackle my most controversial silver thoughts.
As a known gold bug who has admitted to being heavily exposed to silver in the past, I’m expected to be as passionate about it as its silver fanbase.
The problem is that my investing in silver came long before gold, which is why my precious-metal portfolio was lopsided for a long time.
In the near two decades I’ve owned physical silver, I’ve come to realise it’s not as great an investment as the silver bugs claim it to be.
Sure, the price of the metal has seen some extreme highs and lows since then…
Silver price per ounce (pound sterling)
Monthly, 2007 – present
Source: Trading View
… but “cashing in” on silver’s extreme highs is difficult if you’re holding physical silver. (We’ll delve into why another time.)
Yes, I’m in the money on all of those original purchases. Some have even doubled in value since 2004. But at what opportunity cost has this very slow growth come? What other investments did I miss out on by investing heavily in silver in my formative years.
Bimetallic ratios have a complicated history
Too many silver fans are caught up in the idea that silver will revert to the mean of the gold-to-silver ratio. That is, how many ounces of silver would it take to buy one ounce of gold?
At several thousand years old, the gold-to-silver ratio is the longest-running tracked “exchange” rate in human history.
And if you look at the history of this ratio, it’s had very long periods of being at a fixed value, or only moving in small increments.
But first, a history lesson.
The formal ratio was created by Sir Isaac Newton, when he was Master of the Royal Mint. He set the silver-to-gold ratio at 15.5:1. This meant that, in 1717, you would need 15 ½ ounces of silver to buy one ounce of gold.
One of the ideas behind this was the natural ratio of silver to gold in the Earth’s crust, where silver is around 17 times more abundant than gold. However, I can assure you that no one in the early eighteenth century knew enough about the rocks underground to accurately draw that particular conclusion.
Worse for those using this 15:1 peg as silver’s eventual point of return is that Newton’s price fixing was about protecting the Crown’s gold position. Yes, Newton actively devalued silver to ensure the Crown’s gold wasn’t raided.
A former colleague has weighed in on this, pointing out that Newton’s policy was a failure.
The short version is that Newton’s weight fixing led to a shortage of silver as people hoarded it, thinking it was more valuable than the Crown claimed.
About a century later, our friends in the United States started tinkering with their own fixed gold-to-silver ratio. One very dark civil war later, their own bimetallic standard failed, too.
Many passionate silver fans will argue that gold-to-silver ratios of 15, 16 or 17 to 1 suggest this is a “historical” norm, and that it’s only natural for the gold-to-silver ratio to move back to these levels.
Therefore, they say, this is further proof that silver is undervalued.
And yet every time silver has been fixed to gold at this low level, it has failed.
Other silver lovers take it a step further, claiming that, if we use the mining rate of gold-to-silver, for every ounce of gold unearthed worldwide, only nine ounces of silver are mined. Therefore, the market should value the ratio at nine ounces of silver to gold…
Again, this geological ratio is used as a double-down that silver is undervalued versus gold.
The thing is, the market doesn’t value silver this highly. And there’s a reason for that…
Bimetallic ratios are history
There may be a time when gold forms part of the world’s monetary system again, but it’s highly unlikely that silver ever will.
Our history lesson in bimetallic ratios is just that, history.
There’s no reversion to the century-long mean of 50. There’s no plummeting back to a gold-to-silver ratio of 15, like in Newton’s days.
The gold-to-silver ratio average slowly nudged higher after both metals became freely traded, and, since then, the increasing ratio (needing more ounces of silver to buy gold) reflects silver’s decoupling from money and its switch to an industrial metal.
Gold-to-silver ratio, 1915 to present
Source: Macro Trends
Simply put, silver is too useful to society to just be money. Any return to the good old days of silver being valued more closely to gold is off the table now.
The industrialisation of silver is diminishing its role as money, effectively demonetising the metal.
It’s not that silver isn’t valuable. It’s just that its utility is now more important to us than historically.
Commodities evolve with societies
Just as we don’t carve weapons out of stone any more, or gather water from wells in the town square, we don’t use silver in the way we used to.
Commodities and their use have evolved to reflect the society that uses them.
As I mentioned above, many argue that silver should be attributed a much higher value than it has, and that we need only look back at the historical gold-to-silver ratio to see where it should be.
Here’s the thing. When you look at the gold-to-silver ratio throughout history, it keeps moving “up”…
When Bretton Woods – where the price of gold was fixed and the US dollar was redeemable for gold – was in place, the gold-to-silver ratio averaged 40 ounces between 1944 and 1969.
Over the last 50 years, during which both precious metals have been freely traded, the ratio has continued to move higher.
Through the 1970s to 1990s, the ratio averaged 50. In the past 20 years, it has averaged 65.
And over the next 20 years, I suspect the ratio will increase to a higher long-term average once again.
Why is that?
Simply put, we consume silver and we store gold.
Silver plays a vital role in the minutiae of our daily actions. Turning on a light switch, clicking on a mouse, or tapping away on our smartphone.
Gold, on the other hand, is much less useful. It sits in vaults around the world doing nothing.
What’s driving the gold-to-silver ratio to a higher norm is the industrialisation of silver over gold.
Silver has been industrialised because of its incredible usefulness to society. And that’s what’s leading to the new high silver ratio.
There is no reversion to the historical mean. Rather, the mean is dynamic, and slowly shifting upwards.
Until next time…
Co-editor, Exponential Investor