Gold/Silver Ratio Rethink
Most watchers of the ratio of gold to silver have done so in the expectation that it will return to its historical average of around 15 to 16.
It is an interesting aside that this ratio is similar to the reserves in the ground. Gold at 0.004 parts per million of the Earth’s crust, and silver at 0.07 parts per million, gives a ratio of 17.5.
In ancient times the ratio of gold to silver was about 10. In other words, gold was usually perceived to be around 10 times more valuable than silver.
By the middle ages this ratio had increased to around 15. In the 20th century the ratio was in the area of about 50.
(My thanks to whoever put out this graph -Sam Mathid)
At the start of the 21st century the ratio hovers between 65 and 70. It is the conviction that at some point silver must revert to its historical average that gives heart to those who accumulate it.
This is at odds with what is actually observable, which is a consistent increase of the ratio between the monetary metals, particularly from around the start of the 17th century. It is accompanied by rising volatility. That does not in any way resemble a short-term divergence.
Is this an anomaly which will be rectified, or is there a logic to this trend? Does the market of the last 500 years have a reason to discount silver to an ever greater degree?
Can we be certain of a return to the historical average?
A look at the fundamental relationship between gold and silver indicates probably not.
The Bi-Monetary System
The necessity for a bi-metallic monetary system was brought about by two of the different functions of money. One of the relevant functions is as a very high weight-to-value ratio money. This meant that an easily transportable amount could be used to finance such things as large importations of goods, and the purchase of property and other expensive assets. This was one of the jobs of gold.
The other relevant function is as a medium of exchange for daily purchases. It is hard to buy a dozen eggs using gold. Such small transactions were one of the jobs of silver.
Whether in antiquity, where they utilized cows and salt, or in more modern times where we utilized gold and silver, these were the two functions of money that necessitated a bi-monetary system.
However, technological advances over the centuries have allowed us to practically use smaller and smaller amounts gold. This has brought us to the point where in the electronic age it is possible to utilize gold down to fractions of a grain.
These new abilities of gold have increasingly usurped the job of silver.
This suggests that silver’s long-term monetary use for everyday transactions is far from certain. Indeed, the indications are that silver’s use as a money will continue to diminish.
Silver’s Industrial Use
A second factor, that only entered the equation in the 20th century, could be contributing further to silver’s demonetisation. This is its growing electronic, medical and general industrial role. Make no mistake, silver is now a consumed metal.
This places further strain upon its monetary value. If its industrial value is increasing, its monetary value must necessarily be diminishing.
Silver is being consumed in large quantities in ways that make it difficult to retrieve. That must mean that its stock to flow ratio is falling. It is the stock to flow ratio that ensures the stability of value so necessary for a money.
If, as is generally predicted, silver’s industrial usage continues to expand, then this can only create further volatility in its value causing further downward pressure on its monetary value.
Stock to flow ratio, and volatility of value are inversely, but not necessarily proportionally, correlated. If the above ground stock of silver fell below a certain level (whether actual or perceived), then this could lead to a huge decrease in the component value of silver which is attributed to its monetary function. Is this the cause of the 20th century acceleration of a process that started 400 years ago?
Gold’s new ability to be utilized at the granular level, coupled with silver’s increasing use as an industrial metal, suggest a continuation of the long-term trend of a widening ratio between silver and gold.
Those who buy or hold silver in the expectation of a return to the historical ratio of around 15 could be severely disappointed.
It is in the final exponential rise in the value of gold that will accompany the global collapse of fiat money where the greatest gains in silver are anticipated.
It is entirely possible that no such gains will eventuate. It seems more likely that the gold to silver ratio may well, at that point, rise to levels never before seen. In other words, the graph will continue on its divergent trajectory.
When gold does go into the exponential phase it will be because its monetary role will finally be discovered by those who today complacently accept paper quasi-money as real money. When that monetary role of gold is discovered by the masses then the perceived value of gold will sky-rocket.
Will silver go with it is the question? Maybe it will in the short term, simply because of the expectation by some of silver returning to its former monetary glory.
But beyond that initial point, if the gold to silver ratio has increased from antiquity to now, from 10 to 70, then is there anything to suggest that it cannot blow out to 200 or 300, or even 500?
Rather than the value of silver going exponential, it could well be the ratio of gold to silver that goes exponential.
Gold is the best money and has been for thousands of years. It is entirely possible that in our immediate future it will be the only money.
The refusal of the gold to silver ratio to make any predictive sense, or to conform to any theory, lends support to the suggestion that today there is no gold to silver ratio. They have gone their separate paths. Gold is a monetary metal. Silver seems to have a rising a commodity value, and an undefined, but rapidly diminishing, monetary value.
A perusal of the facts, rather than the optimistic predictions, suggest that we are approaching the end of the bi-metallic monetary era.
The graph indicates that it may have ended a while ago, but was not noticed because of the paper money pollution of the value environment.
If it blunts the slings and arrows that are due to be heading my way I hold my hand up to being an investor in silver for over thirty years and to still holding a large stash of silver. This is just my thought for this Sunday.
Jun 20, 2010
© Sam Mathid 2006-2010