Gold vs. Silver : Gold wins, as always

Recently, a wave of panic swept the precious metals markets and there was talk about the end of the cycles of mega-rise in raw materials! And whereas some thought there was a bubble on gold, it was on silver that the bubble inflated, then burst: The Wall Street Journal talked about the sudden   fall in the grey metal which “ fell 12% in just 11 minutes when the fall was at its most severe. Spot silver saw its informal open at $47.863/oz before rising to a peak of $48.150/oz; it then sold off sharply to a base of $42.210 before stabilizing.

The move down is the first break in an extraordinary run for silver, which has more than doubled in price over the past six months as investors bet on rising prices from renewed industrial demand and as a cheap safe-haven alternative to gold.”.

A piece in the  Financial Times asked  “Did the Silver bubble just burst?”,  illustrating with a chart that “the grey precious metal has tumbled 20 per cent in a week”.

The feeling was that a rapid rebound would be unlikely as expressed by Phillip Klapwijk, executive chairman of the precious metals consultancy GFMS, who said of silver’s position, “I think it could be over on the upside for the next little while.”

The FT also explained the extent of the early May slump saying “Silver prices plunged for the fifth consecutive day on Friday(6th May) as the grey precious metal suffered its biggest correction since the billionaire Hunt brothers cornered the market in 1980.” As the week drew to an end they summarised “The reversal of fortunes for silver – which until this week’s 25 per cent drop had been up 56 per cent since January – has led a wider sell-off in commodities markets, which were heading towards one of their worst one-day falls on record.”

Market manipulation rumours were rife and silver faced additional challenges because of rule changes by the CME Group. “The volatility in silver has been exacerbated by a series of increases in margin – or the amount of cash that investors must set aside to trade each contract – by CME Group, which runs the silver futures exchange in New York.

CME has raised its margin requirements five times in the past 15 days. Investors must now set aside $14,000 per silver futures contract, worth about $180,000 at current prices. The rate will rise to $16,000 on Monday (9^th).”

The grey metal, with a predominantly industrial use, is traditionally much more volatile than gold.

So where does gold feature in all this?

According to the FT “gold has managed to remain relatively unscathed compared with its poorer cousin”

It remains on top, as always!

Silver has never been able to compete with gold

For a long time, these two precious metals have been linked by a ratio of 10 to 15.5. In the time of the Pharaohs, it was said that there was a ratio of 13.3 between gold and silver. In 440 BC, this ratio was of 13 during the Roman Empire it was set as 12.

In 1876, Henri Cernushi wrote in “The Bimetallic Currency” that “gold and silver are two natural and eternal currencies. Nobody can produce them artificially nor by decree and this is why they remain a trustworthy guarantee”. During this era most fiduciary systems fixed the parity between gold and silver at 15.5.
In 1840 Europe, the situation was tense because almost everyone felt that there was a tendency to believe that the ratio of 15.5 tended to overvalue silver.  Indeed the grey metal was abundant due specifically to heavy production in the United States.

These historical references are interesting because they are not too distant from geologist’s estimates that Silver is 17 times more abundant than Gold in the earth’s crust. This has given rise to some investors believing this ratio is the natural balance between the two metals and that one day we should somehow return to it.

Many traders, speculators, and investors focus on the gold/silver price ratio in determining which metal is under or overvalued. In recent weeks and months the ratio has collapsed from above 65:1. The ratio of gold to silver prices is at its lowest since 1980, and has plunged from 46 in January this year to 33

Throughout the twentieth century, the gold/silver price ratio went to nearly 100:1, occasionally dipped below 30:1, and only briefly hit a ratio of 17:1 in 1980.

Put against gold, silver does look distinctly volatile and vulnerable.

Simone Wapler (Editor of MoneyWeek France) writing in La Chronique Agora explains why this ratio dropped:

“The gold/silver ratio collapsed because gold, like silver, has been demonetarized. Silver even more than gold. The central banks still have some gold in their coffers, but not silver. Gold is always popular in the jewellery market, but aside from  monetary uses, the uses of silver are in decline (traditional  photography, silverware). For many silver is just a poor man’s gold. When one cannot afford gold, one buys silver.

However this argument although valid is not strictly true because of innovations that make gold investments even more accessible and in a way that is not restricted by individual budgets.

Investors no longer need to settle for second best when they can have the real thing.

It is now possible to start investing in gold by the gram including a savings account that encourages investment in physical gold (that you own outright) with a plan to start from as little as 1g of gold per month.”

Similarly this form of investment is finding increasing favour from businesses looking to protect their contingency funds against inflation and the risk of traditional portfolio investments that are vulnerable to sovereign and national debt issues. Holding physical gold as an owned asset has an increasing appeal   as an investment with security and profits.

But when the figures speak for themselves…

Simone Wapler also adds that “when gold goes up, so does silver, but to a lesser degree. When gold drops, so does silver, but to a greater degree”.   Furthermore, gold gains twice as much as silver during a rise yet silver loses twice as much as gold during a fall. Before the bubble on silver this rule was proved, clearly meaning that something was going on. The sharp current correction reminds us that there was an unfounded rush on silver- and today the rate should be around 25 euros. Above that it is overheating.

If you are not convinced, here is a brief outline of the evolution in the rates for silver and gold, in recent days and over the last 5 years.

In short, when gold sneezes, silver catches a cold, and when silver starts to take take-off, gold reaches towards its peak!

Gold remains a safe haven

According to the French daily Le Monde, one reads that in spite of the fall in rates, “gold should remain protected by its status as a safe haven when faced with inflationary threats, and a prolonged decline in oil prices does not appear very likely. Worldwide demand remains solid and supply remains under the shadow of tensions in the Arab world, with light crude from Libya still cruelly lacking.”

In MoneyWeek France we are told that “Falls are necessary and compulsory in a large bull market we are more than ever convinced that gold has a promising future ahead. Let’s give time for the new world order to be created, for the former rich countries to become aware that they are the new poor and that they live well above their means… in short, there is still quite a while to go”.

Arguments in favour of gold

Indeed, gold has recorded a slight fall recently, but if you need additional arguments to be convinced of its role as a tangible asset;

• gold is “reconverting into money”: it is clearly not the case for silver
• silver has lost its status as a safe haven contrary to gold
• silver is a rare industrial metal, very volatile just like other raw materials.   Let us take for example palladium: the market for palladium remains confidential and prices extremely volatile. The production of palladium is concentrated within Russia and in South Africa. This concentration of production confers a certain instability in the market with regards to price and reliability of supply. And uncertainties with regards to its provision have even caused the price of palladium to rise in October 2010, reaching its highest level since June at 605.13 dollars an ounce. Demand is increasing consistently, mining development is limited, a hold by the Russian State on reserves and lack of investors: such are the characteristics that have led to the palladium market finding itself in deficit.
• silver is not a product for protection against crisis. It is rather comparable to platinum which had fallen in 2008 because the automotive industry was at its lowest point (noteably platinum is used in catalytic converters)
• silver is increasingly rare and difficult to revalue. Silver is a non-renewable resource and experts agree that by 2021 -2023 the exhaustion of silver supplies will be final.  In any event, silver is a metal which cannot be synthesized and for which no substitute exists. And even if the exact date of a drain in the metal market still remains on hold, in 2010, with a production of 19,300 tons, and demand standing at 25,200 tons, reserves are clearly running low. Remember that principle industrial uses consume the silver
• silver takes up space in storage, and savers prefer gold which in value and in volume is better
• because of its scarcity, industrialists are trying to replace silver as soon as possible. This  linked article deals  with the uses of silver in particular in the manufacture of RFID Tags for stock control and identity cards. If we imagine that one day industrialists find another metal or synthetic to replace this need what leeway will remain for silver? This article is based on a completely biased study of silver. All industrialists say if one day they are able to do without silver, they will do so because it is expensive. The use of gold in industry itself remains limited compared to its use for investment purposes and jewellery.

This is exactly what one is looking for from gold, once again it becomes  a private currency, regardless of form.

Let us leave silver to those who want to get their fingers burnt with molten metal…

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Gold vs. Silver : Gold wins, as always was first posted on May 23, 2011 at 9:30 am.
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