May 22, 2020 | Why The Gold/Silver Ratio Is A Useful Indicator

There’s a debate in gold bug circles over whether the price difference between gold and silver – the gold/silver ratio – tells us anything useful. Some skeptics, for instance, view the original gold/silver ratio of 15 — from America’s 18th century bi-metallic system – as just a political number pulled more-or-less out of thin air by Alexander Hamilton and therefore useless today. Others note that gold is a purely monetary metal and silver is part industrial, part monetary, and conclude that it’s apples to oranges — and therefore not an indicator of future prices.

Both points are factually defensible, sort of. But they’re also irrelevant. The real reason the gold/silver ratio has tended to fluctuate within a broad but well-defined range is that humans have a vivid visual imagination. Here’s how it works:

Early in a precious metals bull market, people are skeptical of the need for safe-haven assets, so the money that flows into the sector goes mostly to the big-name, super-safe choice, which is gold. Gold goes up relative to silver, and the gold/silver ratio expands.

Gold keeps rising and new money – much of it attracted by the metal’s newfound price momentum rather than an understanding of the nature of money – flows in, pushing gold even higher.

The early gold investors register big gains and begin to feel smart and therefore more willing to take on a bit of extra risk in return for potentially even bigger gains. They look around for “the next gold” and find silver, the other monetary metal, languishing at a relatively low price.

Then they start thinking in images. First, they picture a single one-ounce gold coin and consider what it would cost. At gold’s new, higher price, this seems like a lot of money for such a small, though admittedly pretty, thing.

Next, they consider the price of silver and envision how many – also very pretty – one-ounce coins they can buy for the price of a single ounce of gold. And their imagination conjures up something like this:

Suddenly, silver looks extremely cheap. For the price of a single Gold Eagle, one can get two heaping handfuls of shiny, heavy silver ounces.

A bit more consideration reveals that in a SHTF scenario, silver coins are actually more useful than gold because their smaller denominations allow them to function as $20 bills rather than gold’s illiquid $1,000 +. You can buy groceries and bullets with silver coins.

Suddenly aware of silver’s advantages, investors conclude that at current relative prices, the choice is a no-brainer. Silver is the precious metal to load up on.

Adjust this thought process for the global pandemic’s distortion of most  markets and convert it into a chart, and you get the past two months’ gold/silver ratio, which depicts a bout of hair-on-fire panic followed by a trend back towards traditional norms:

So what happens now? Historically, both precious metals keep rising, with silver rising faster than gold until the imagined pile of silver required to buy a single ounce of gold looks something like this:

Then the process shifts into reverse, with a single gold coin looking better in the mind’s eye than a paltry few bits of silver.

We are nowhere near that point, so expect investor imaginations to work in silver’s favor for years to come.

John Rubino May 22nd, 2020

Posted In: John Rubino Substack

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