Silver Keeping Pace with Gold; Set to Outpace Gold

Silver Stock Report

by Jason Hommel, January 9, 2008

Some of my readers are wondering where I've been.  I'm ok, I just bought a house and moved.  It's a little disruptive to writing.  I was renting, to avoid wasting my money in real estate.  But my wife is pregnant now, by 3 months, and so we bought a house, to avoid having to move again.  And we did get a "dream home" of 4200 sq. feet on 7 acres in the most beautiful spot in the world, in Grass Valley, CA in the foothills of the Sierra Mountains.  I only "wasted" about 9% of my net worth on this home, and I can afford the loss as real estate continues to decline.   Also, I have about 3 times as much wealth in the form of physical silver, which is my largest single investment, by far.

For a few months now, people have been wondering why the silver price seems to be lagging behind the gold price.  After all, in 1980, gold hit $850/oz., and silver peaked out at $50/oz.  But today, gold is making new all-time highs at $890 today, while silver languishes at a mere $15.83 as I begin this article this evening.  My wife thought it was no coincidence that Ron Paul was on Jay Leno last night on Jan 7th, talking about the need for "Constituational" gold and silver money after having been excluded from the Fox News Republican debate.  Jay Leno was shocked at the snub, as Ron Paul has raised more money than any of the other candidates!

So, silver rose from $15.22 earlier today to $15.88 now!  That's up 4% in one day!

In recent years, from about 2001, the ratio of the price of silver to gold has risen from about 70 to 80 ounces of silver, for 1 ounce of gold, to about 56, where it stands today.  In fact, in the past 6 months, the ratio has remained rather steady at about 55 to 1. 

In 1980, the ratio had returned to the historic 15 to 1 ratio. 

So, only when compared to 1980, can silver still be described as "languishing".  Yes, it might be said that we are still at the bottom of a 27 year bear market for silver.   (But now, we have "price action" and a price "breakout!")

But if you consider the time frame of the past 6 years, silver is outperforming gold, as the number of ounces of silver needed to buy gold has narrowed from 80 to 55.

So then, why is silver not at $50/oz. yet?

The reason, I think, is that gold is not at $850 (circa 1980).  The reason is that the measuring stick of the dollar is completely broken. 

We must adjust for inflation since 1980.  Today's gold market will be like the gold market of 1980 only after you adjust for inflation.  We are not there yet.
 But a key difficulty is: "How should we adjust for inflation?" 

We can adjust via the CPI, the government produced inflation statistics, but these, most agree, understate inflation.

An online inflation calculator quickly shows that $850 in 1980 is really $2275 in 2006.

http://www.westegg.com/inflation/

However, my research shows that M3 in 1980 was $1.8 trillion.  Today, M3 is just over $13 trillion, as pointed out by http://www.nowandfutures.com/key_stats.html#m3b

So, 13 divided by 1.8 is 7.2, which is what we need to multiply the 1980's gold price by, to get a more accurate "money creation inflation" adjusted price for today's dollars.

$850 x 7.2 = $6120

Gold, today is not at $6120/oz., and therefore, there is not the same kind of excitement about gold today like there was in 1980.  By the time gold hits $6120, or a somewhat higher price by the time we reach it, because it will take time to get there, and during that time there will be even more dollar price inflation by which to adjust, I would only then expect a similar excitement about gold that existed in 1980.

I believe it is that kind of excitement that will drive the ratio price of silver to gold back to the historic norm of 15:1, and most likely exceed it.

So, by the time gold hits $6120/oz., or higher, silver will hit $408/oz. or higher.  (Because $6120 divided by 15 equals $408.)

And by then, silver will have merely "kept pace" with gold, having returned to the historic ratio.  And that's what we could expect if the investment outlook for both metals was about the same.

However, for a whole host of reasons which I will now list, I expect the silver price to do significantly better than that. 

Primarily, the silver to gold ratio held for hundreds of years at about 10-15 to 1, during which time silver and gold were money around the world.  But in the late 1800's, Germany stopped using silver as money, and silver began to be "demonetized" as nations went to the "gold standard". 

The Democrats in America, back in the late 1800's supported silver as money, while the Republicans supported only gold as money, but not silver.  The Democrats were seen as inflationists, on the side of debtors and the masses of people, while the Republicans supported creditors, such as banks and businesses. 

The original story of the Wizard of Oz was like a parable of the battle between silver and gold.  The original "ruby shoes" that Dorothy wore in the movie were really originally "silver shoes" that would set everything all right again, and end the nightmarish fantasy of the "yellow brick road" which was a symbol of the gold standard, and backed up by nothing more than a funny man in an Emerald City (green paper money) who made loud scary noises behind a curtain.

Today's Democrats have morphed into a party that still supports inflation, but via higher government domestic spending programs.  And most of today's Republicans have morphed into a party that tries to defend the value of the dollar by waging war on nations that think of selling oil for Euros instead of dollars.

I explain all of that, because I find it fascinating, but also because it goes to show the reduced monetary demand for silver was a trend that started over 100 years ago.  This very long trend of a reduced monetary demand for silver continued all the way until 1964, when it really accelerated and was completed, which was the last year that silver was coined as money in the U.S.  But the demonetization trend continued as old people of the last of the "silver money era" die off as they are doing today, and as ignorant 60 year old baby boomers inherit that silver, and typically sell the silver to invest in the real estate bubble.

I believe that trend of "silver demonetization" of over 100 years is now over, and ended for good.  Why?  Because people are going to make tons and tons of money as silver rises from $15/oz. to over $408/oz., and people are now seeing the potential of that, and are investing money into silver, and using silver as a store of value again, which, in other terms, means a return to "monetary demand". 

Money, after all, serves several purposes, as a unit of account, a means of exchange, and a store of value.  As investors buy silver to make money, they are using silver as money (as a store of value), and this is the return of monetary demand for silver, which is the reversal of the trend of over 100 years.

But a funny thing happened to silver just over 60 years ago.  The age of electronics began.  At the end of World War II, there was a boom in the use of electric devices that needed silver for the electrical contact switches.  Per capital silver demand skyrocketed in about two years, up tenfold, from about less than a tenth of an ounce of silver used per year, to nearly 7 tenths of an ounce of silver consumed per year per person in the U.S.  And that rate of silver consumption has stayed about the same ever since.

During that time frame, I estimate that about 8 billion ounces of silver were consumed in the U.S. alone, most irretrievably lost forever to be re-deposited back into landfills, and never recycled, nor recyclable.  That's about 1/5 of all the silver ever mined by all of humanity.  The rest of the world probably consumed the other 3/5ths of the silver, leaving less than 1/5 remaining.

Most of the rest of the silver sits in forms that are uneconomic to recycle.  For example, you may have purchased a silver ring recently for $25, and it may contain about 1/5th of an ounce of silver.  Well, you just bought silver at $125/oz. or so if you have purchased any silver jewelry.  Silver is even more expensive if it is in the form of tableware or cups. 

So, although monetary demand for silver is slowly beginning to return, it still has not started yet in any significant and meaningful way.

Silver investment demand may only be about 50 million ounces per year, while silver recycling probably stands at about 200 million ounces.

So, with so little silver available for investment, silver is easily set to outpace gold, and exceed the historic 15 to 1 ratio by the time there is any public excitement about the precious metals.

By the time even 1% of the nation's $13 trillion in liquid wealth tries to buy gold and silver within a year, the price of gold will probably exceed $3000/oz., and the price of silver would probably exceed $150/oz.

Let me show again how small the silver market really is.  The annual production is about 650 million ounces, with recycling about 200 million, and other silver sold about 50 million ounces.  That's a total of about 900 million physical ounces of "fresh" silver entering the market, in a year.  That is balanced by about 900 million ounces of consumption, which is balanced by about 45% demand in electronics, about 30% demand in jewelry, and about 20% demand in photography.  About 5% is investment demand.

Oh, I suppose more silver than that actually trades each year, as some investors sell silver to other investors, but that's the total net flows.

But if new investors enter the market, they will have to displace that 900 million ounce annual flow (which can only be done at higher prices), and there is little silver left for any new significant monetary demand, that will surely be coming in the near future now that inflation is picking up.

Another way of looking at the 900 million ounces of silver per year, is that it's about 2.5 million ounces per day.  That's not much in the way of finance.  And since only 5% of that is purchased, net, by investors right now, which is only 125,000 ounces of silver per day, in the entire world, purchased by investors. 

That's a tight market.  Set to explode in price. 

All of this is literally guaranteed to make a few certain wise people, such as you, very rich.

As silver moves from $16/oz. to $408/oz., which is literally guaranteed by historical ratios and historical inflation measures, and insured by the silver scarcity, many people will make well over 2500% (as denominated in dollars) on their silver investment.

Over what time frame?  Who can say?  I expect annual returns to average about 50% until that final goal is reached.

As always, don't keep your silver with anyone who says they want to hold it for you.  Get the scarce physical stuff.  All the major brokerage houses and big banks practice "fractional reserve silver holding" for all their clients, and you are not guaranteed anything in the event that they go bankrupt. 



Sincerely,

    Jason Hommel

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