New, Improved Confusion on Gold & Silver
By Franklin Sanders
monetary metal in history is silver, not gold."
February 13, 2006
-- Milton Friedman
In his Feb. 8, 2006
lewrockwell.com article, "Buy
Silver Or Gold?" Dr. Gary North answers, Don't buy silver
- or at least, don't buy much. With all due respect to Dr. North,
his article was filled with rather large factual errors that
lead to wrong conclusions.
Fact is, over the life of the present precious metals bull market
silver promises a much greater return than gold, say, 400%. What's
more, unless your investment strategy is "dipped in cement,"
you will shun Dr. North's idea of "core holdings."
Rather, you will pile up as many ounces as you can by swapping
back and forth from gold to silver as often as you can.
IT HAPPENED WHEN?
Dr. North writes, "In June, 1963, the government passed
legislation severing the legal connection between silver certificates
and silver." This is an error. That legislation was not
passed until June, 1967, allowing a year for holders to redeem
circulating certificates in silver.
On the other hand, the shortage of silver coin was by 1963 already
becoming obvious, thanks to the rise of coin-operated vending
machines and the government's longstanding policy of selling
silver at below-market prices.
Throughout the Fifties the federal government created
high silver demand by selling silver at a below market price,
90 cents. It was, by the way, also below the statutory
$1.2929 price. The government began that period with history's
largest silver hoard, over three billion ounces accumulated between
1933 and 1963, and over 2 billion left in 1959,). Roosevelt's
silver market manipulations had accumulated most of this. His
ill-conceived and worse-executed scheme to raise the silver price
wreaked havoc on the world market and finally forced China off
the silver standard and into the Depression with the rest of
the world. After World War II the government began feeding the
huge silver hoard to silver users as a long term subsidy.
Dr. North contends that silver was demonetized in 1963, but in
fact that happened nearly 100 years earlier, in 1873.
Otherwise, the tricks the government pulled in 1963 would never
have been possible.
By 1934 both silver and gold were in a similar state of "demonetization."
Governments had officially stopped using them as money, but the
world - those troublesome individual human beings - still regarded
them as money, as they do today. This regard waxes and wanes
directly with public confidence in central bank fiat money.
True, central banks still hold gold as "reserves,"
but in the same way housewives hold a toilet brush - reluctantly
and at long arm's length.
Given the history of fiat money, and its performance in
this century, it is hard for rational people not to conclude
that fiat money is nearing the end of its spectacularly
pernicious run. If it collapses altogether, then the dollar will
disappear, and the elitists who run the US and its money supply
will return to silver and gold - but only after their fiat
money has impoverished the rest of us.
WHEN DID SILVER BOTTOM?
Dr. North also writes, "[Silver] then fell for the next
23 years, bottoming at $4. 67 in January, 2003."
My bewilderment disables me from guessing how Dr. North arrived
at this price and date for silver's "bottom."
During the 1990s silver made a very long bowl-shaped bottom,
a very reliable bottoming pattern. On 22 February 1991 silver
hit its low, $3.59, and on 1 March 1993 posted a double bottom
at 3.60. On 27 November 2001 it made one last visit back toward
that level, closing at 4.065 (all are closing prices).
Why Dr. North chose January 2003 and $4.67 as the "bottom"
utterly mystifies me. The low close for January 2003 came at
4.765 on 14 January. From a technical standpoint the bottom came
on 27 November 2001 at 4.065.
A FAILED INVESTMENT?
Dr. North writes, "Gold is perceived as a money metal that
is used by central banks. It is used by Asians as an inflation
hedge. Silver has lost that perceived value. So, silver is more
volatile. There was nothing to prevent its fall after 1980."
So silver is dead as an inflation hedge? Among Asians? Maybe
Dr. North ought to inform those millions of Indian farmers who
still store most of their wealth in silver.
On Dr. North's statement hangs all our investment strategy. If
it is true that the world has turned it back on silver
as an inflation hedge - or, better stated, as "money"
- then we ought to shun silver for gold. But if this statement
is false, we ought to buy both and form a bimetallic
strategy that leverages both metals' strengths in our favor.
(Remember that I call "monetary demand" demand for
silver as silver, which some call "investment demand.")
Besides, Dr. North's statement is also false historically.
Look at silver's history from 1873 to 1980. Once U.S. demonetized
silver in 1873, followed closely by Germany, then huge monetary
demand was removed from silver and its price entered a long decline.
The gold/silver ratio (the number of ounces of silver required
to buy one ounce of gold) rose (remember, silver is becoming
cheaper against gold, so it takes more silver ounces to
buy a gold ounce). By 1914 it had climbed from 16:1 to 41.19:1.
During World War I Indian monetary demand kicked in, dragging
the ratio down to 15.49 in 1919. From there silver entered a
long decline (monetary demand was shrinking) until the ratio
peaked at 100:1 in 1941.
After a long period of government-fixed prices, monetary demand
revved up again in the early 1960s. Even Dr. North himself confesses
that he was driven by monetary demand for silver in 1963.
Which brings us to the one key necessary to understanding silver
and gold: It is not industrial but monetary demand that
drives the price of silver and gold crazy. Once
you understand that, you'll stop worrying about the silly yearly
supply demand surveys.
According to Dr. North "There was nothing to prevent [silver's]
fall after 1980." Of course not. Fed
chairman Iron Paul Volcker screwed interest rates up to 25% trying
to suck monetary demand away from metals, so silver's price fell.
Does that surprise anyone? Matter of fact, gold's price fell,
too, from the same cause. From its 1980 peak to its 1991 bear
market low, silver lost 93%. From gold's 1980 peak at $850 to
its bear market low of 253.70 in August 1999, gold lost 70%.
Since bear markets generally lose 50% to 95% of their foregoing
bull market peak, both these are merely normal performances.
IS THE SUPPLY GAP ARGUMENT FALSE, TOO?
Dr. North writes, "For almost the entire 23 years of its
price decline, there were bullish silver brokers who kept talking
about the huge gap between low silver production and high silver
consumption. Here is my question: If that argument led to losses
for 23 years, why should anyone believe the same argument today?
There was a negative correlation for most of those 23 years between
that argument and the price of silver."
Zoot alors! Again, this is very strange. Dr. North has
the period all wrong. Nobody has been claiming a supply shortfall
for 23 years (1980-2003?), but only since 1989. The years before
1989 were surplus years when more silver came to market
than fabrication consumed.
At least, they showed that way in "official figures"
until the "officials" changed the figures. Truth to
tell, there aren't any "official" figures, only figures
from Gold Fields Mineral Services (GFMS) and CPM. Until 1995,
when GFMS took over, CPM Group compiled the yearly World Silver
Survey for the Silver Institute. Contrary to Dr. North's
implication, the numbers for the entire series of years change
very much from yearly survey to yearly survey, enough
lately to render them ridiculous and just about worthless. By
the very nature of that survey, the "figures" can never
be more than sophisticated guesses, interpolations, and inferences.
And in all fairness, the world silver market is far too vast
and diverse for anyone to track each & every transaction.
So all the figures available for silver supply and usage
are very unofficial. Fixing those numbers is like shooting
skeet off the back of a bass boat in a thunderstorm. What makes
the figures even more baffling is that GFMS revises them all
Roughly, here's what has been happening with silver supply and
demand. About 1989 supply began to fall short of fabrication
demand, resulting in a "structural deficit" (fabrication
demand greater than mine supply and recycled scrap). That shortfall
has persisted ever since. Depending on which yearly survey's
figures you take, the shortfall averaged 100 million ounces (moz)
per year for a total of 1,515 moz 1989 - 2004. The shortfall
has ranged from 1.9% of silver used in fabrication (1989) to
20.2% (1994), or about 12% of yearly fabrication demand. (Using
the 2004 figures, which GFMS jimmied and jived considerably from
the 2003 figures.)
These shortfall figures may jump and vary, but the inference
remains that about 1.5 billion ounces of silver was burned
up from 1989 through 2004.
How then (Dr. North asks indignantly) could silver's price remain
so low in face of that demand pressure? Simple. About
one billion ounces excess to demand had come to market
from 1980 through 1989. That excess had to be worked off before
the price could rise. Now that has happened. One billion ounces
excess less one and a half billion ounces shortfall leaves half
a billion ounces shortfall - more or less.
Two observations are needed here. Dr. North may not see any
plausible explanation for silver's long price lethargy while
facing such a shortfall, but in fact traders know that commodity
shortfalls can persist for long periods without price adjustments.
Oh, the price always adjusts eventually, but not with
mechanically predictable precision. It's a market, and markets
are made of humans, and humans are mysterious. Besides, we can
never exhaustively know all the factors in any market.
Second, commodity demand does not drive the prices of gold
and silver. Write this in your book, yea, grave it
upon your walls.
Both silver and gold are "industrial metals" in the
sense that both have some uses that are not monetary. But industrial
demand and supply change only slowly over time. The price
of gold won't shoot up 25% in one year because gold jewelry suddenly
becomes fashionable and women begin buying more necklaces. Rather,
the real price mover for both metals is monetary demand
that hits at the margin and changes suddenly and massively when
confidence in fiat money wanes. Think of the way crowds
move, swayed by fashions, rumors, and panics. The same humanity
is what really moves silver and gold.
GOLD LEASING & THE CARRY TRADE
In the last 10 years or so gold's price has been most strongly
influenced by the "gold carry trade." Through private
bullion bank acting as middlemen, central banks have loaned gold
at ridiculous rates, 1.5% and lower. Borrowers could borrow gold,
sell it into the market, and invest the proceeds in risk-free
government bonds paying 5% or more. Back up the truck: free
money! And if this gold "carry trade" suppressed
gold's price, well, the central bankers weren't crying, since
they needed to do that to hide their inflation anyway.
And although Dr. North seems unaware of it, at hands of the same
bullion banks a silver carry trade has also flourished,
only more so. If central banks actually hold all the gold
they claim (32,000 metric tonnes) and roughly 800 moz of silver
exists in Comex, Tocom, and European dealer stocks, then we can
estimate that for every ounce of gold there is one ounce of silver.
Plainly, there's not nearly as much silver as everybody thinks,
and it is steadily being consumed.
"No central bank holds silver," says Dr. North. Right,
and that's one of the greatest arguments in silver's favor,
since it makes it harder for central banks to manipulate silver.
"Finally, if the bullion
banks are ever asked to repay the gold, the gold bullion market
faces a day of reckoning: massive buying by shorts (bullion banks)
or else the widespread awareness that central banks do not have
as much gold to sell off to keep down its price. Both events
would drive up the price of gold. There is no comparable upward
pressure for silver."
Dr. North errs. There has been a massive silver carry trade.
The massive short covering rally that will hit gold thanks to
the carry trade will hit silver just as hard, or harder. Only
since silver is a smaller, thinner market, the short covering
panic will drive silver's price farther and faster.
THE GOLD/SILVER RATIO:
PHANTASMAL OR FAITHFUL?
"There was a close correlation [between silver and gold]
for many decades: 15 to one. That was because this ratio was
set by Federal law. It was a price control. Gresham's law always
Dr. North has it upside down. It has been centuries, not
decades. Before the 20th century, governments were setting a
price by chasing the market. But let me start at the beginning.
Since memory runneth not to the contrary and as history records,
there has always been a system of bimetallism using both metals
as money. Bimetallism enables both metals to be valued by an
independent yardstick: the other metal.
In early Egyptian times (3200 BC) it took as little as 2.5 ounces
of silver to buy an ounce of gold, or as much as 10 ounces (1,000
B.C.). Until New World silver supplies began pouring out after
1492, the ratio ranged from 7.5:1 to 12:1. In 1497 the Spanish
mint ratio was fixed at 13-1/3:1. By 1641 it had climbed to 14:1,
then 16:1 in 1690. By 1785 it was 15:1 in France, 15.5 in Great
Britain, and 16:1 in Spain.
With deliberate purpose in 1792 the newly formed US government
set its gold silver ratio at 15:1 lower than the world market,
to draw silver into the country. The lawmakers viewed silver
as the more useful of the two metals, since it was the metal
mostly used in domestic trade, while gold was used chiefly in
international trade. The first US congress by the Coinage Act
set the ratio at 15:1.
But rather than skewer themselves on a fixed price scheme, they
set up a symmetallic system where silver was the country's
official money, with supplementary gold coins valued in silver.
From time to time the gold coins' size could be raised or lowered
according to changes in the world market ratio, while the silver
coin remained unchanged. (This was actually done in 1834, without
cheating a single person, but that's another story.)
Plainly, from 1500 to 1873, government "price fixing"
kept on chasing rather than setting the market. Adding New World
silver to world supply raised the ratio (lowered the silver value
against gold) nearer to the natural occurrence ratio. (In the
earth's crust is found about 17 times as much silver as gold.)
Any ratio movements from 1941 through 1963 are virtually meaningless
since government fixed the gold price and the US government was
selling silver out of history's biggest stockpile. Only after
gold's price began to move in the London market and the US silver
market re-opened in 1963 (Roosevelt had suppressed it in 1934)
does the ratio begin to resemble a market-determined price.
Then we find that in a bull market the ratio sinks toward 16:1
and lower (14.59 in 1967). Hey, wait -- we already knew
that from the World War I rally. That also took the ratio below
16:1 in 1919. In the 1980 bull market blow-off the ratio sank
again beneath 16:1.
So how can we understand Dr. North's categorical assertion, "[T]he
gold/silver ratio as a forecasting tool produced only losses,
1980 to 2003."
Could any statement fly more squarely in the face of the facts?
I know of no single market forecasting tool (other than the equally
reliable Dow Jones Industrial Average measured in gold dollars)
that more accurately forecasts the primary trend. Without the
ratio dropping, there is no bull market in metals; without the
ratio rising, no bear market. Period. Like every other
market or indicator, the ratio zigs and zags, and on any particular
day in a 20 year bull market, the ratio might drop. Its long
term trend, however, will solidly follow -- indeed, point out
-- the metals' primary trend.
The ratio topped in 1914 at 41.16 and bottomed below 16:1 in
1919. From there it rose to 100:1 in 1941, then fell until it
touched below 16:1 again in 1967. Climbing to 47 in 1973, it
then dropped below 16:1 again in 1980. Silver fell from 1980
until the ratio hit 100:1 again in 1991, and dropped to 40:1
in 1998. It climbed from there until June 2003, topping at 82,
and has since dropped to around 58 today.
When any commodity returns to the same levels two, three, or
four times during 100 years' trading, I begin to suspect a pattern.
And while past performance is no guarantee of future, a reasonable
man would bet that from 1991's 100:1 we are headed toward 16:1
before this bull market ends, say, 10 years from now.
If gold reaches $1,250 (a modest target only 5 times its bear
market low) and returns to a gold/silver ratio of 16:1, silver
would reach 78.80. In other words, it would outperform gold 400%.
After the gold/silver ratio hits 16:1, only a person who
habitually draws to inside straights would believe metals were
going to keep rising. To anyone familiar with the primary trend,
the ratio has not been forecasting error, but perfect accuracy.
GOLD/SILVER SWAPPING STRATEGY
Dr. North also decries swapping back and forth from silver to
gold. However, that's the only investment strategy that enables
an investor to increase the ounces he holds while waiting for
prices to rise. Besides, the size of the gains is more than enough
to overwhelm the tax disadvantages (since 1984 the IRS has refused
to treat exchanges of gold for silver and vice versa as "like
For example, a ratio move from 62 to 46, less a generous 10%
for transaction costs, brings a 15.1% gain. If income tax gobbles
up half the gain, that still leaves 7.55%, a respectable gain
for no more effort than swapping silver for gold. And the alternative
is zero gain.
Finally Dr. North warns that silver is heavy, bulky, and trouble
to store. True, true, I will admit that he's got me there.
Still, but it will seem a lot less trouble at $78.80 an
-- Franklin Sanders
©2006 The Moneychanger
has edited and published The Moneychanger newsletter
and brokered physical gold and silver since 1980.
You can find
more of his articles at at www.the-moneychanger.com