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Silver vs. Gold

August 1, 2004

Which should you buy, and why? Which will prove to be the better investment in the long term? Let's compare and contrast.

Why is gold useful, and why is it particularly useful as money? Gold is valuable & portable because it's rare & not easily counterfeited. Gold is fungible & exchangeable because every bit of .999 fine gold is similar enough to be like another. Gold does not rust as it's imperishable. These properties make gold a good store of value, a medium of exchange, and a unit of account. Therefore, gold is easily tradable with a narrow spread, meaning it has a small price between the bid and ask-the prices to buy and sell. Gold is therefore the ultimate liquid asset, a luxury, and is why gold is money.

But silver has nearly all the same properties, with a few minor exceptions. Silver is less valuable than gold, as seen by the ratio between them. The ratio is simply the number of ounces of silver that it takes to buy one ounce of gold. As I write this Sunday, August 01, 2004, this number stands at 59.63, with silver at $6.55/oz., and gold at $391/oz. This means that an equivalent value of silver is heavier than gold, and thus, less portable. Why carry around 60 ounces of silver when you can carry one ounce of gold? But it's not as if you cannot transport silver, and it's not as if you cannot ship it. A bag of 90% silver coins, that weighs 55 pounds, and is worth about $4500, can be taken to the post office and shipped via registered mail, for about $56, which is slightly over 1% of the silver value.

Gold cannot tarnish. Silver will tarnish. But the tarnish on silver does not mean it is a wasting asset, the tarnish is very minor. Silver coins still exist from Roman times, 2000 years ago! In fact, if silver did not tarnish, it likely could not be used to make photographs! Silver's chemical reactivity helps to make it more useful. So, that silver does tarnish, a little, is actually a benefit for silver, because it creates additional industrial demand!

This brings me to the next key difference. In refined form above ground, such as in bars & coins, silver is more rare than gold! Few realize or know this!

How much gold is there? It is said that 95% of all gold mined in the history of the world continues to be held by mankind. How much is this? According to the World Gold Counsel, the world has mined 145,000 metric tonnes by the end of 2001. If we add the 2500 tonnes per year through the end of 2003, it's 150,000 metric tonnes, or 4.82 billion ounces. See link: http://www.gold.org/discover/knowledge/faqs/index.html If 95% if that gold is still with us, that's 4.58 billion ounces of gold in the world. (That includes gold jewelry.) Another way to say it is that mankind holds about 50 years' worth of mine supply of gold.

Now, how much silver is there? According to the two industry silver surveys by the silverinstitute and the cpmgroup, the mankind has about 250 million ounces to up to 650 million ounces of silver. (Those numbers do not include silver jewelry.) If we use the larger number, there is about seven times as much gold in the world as silver! (Another way to say it is that mankind holds less than one year's mine supply of silver.)

So, why not include silver jewelry in the comparison? It seems as if I'm not being fair with the numbers. However, there is a good reason not to include silver jewelry. As explained, silver is not as valuable as gold. When silver is made into jewelry, there is valuable skilled labor involved, which adds to the price and value of the object. A very cheap silver ring will cost about $10, and will contain about 1/5 of an ounce of silver, or less. This means the cost of that metal, in that form, is about $50/oz.! This means that silver, in the form of jewelry, cannot be sold for a profit for the sake of the value of the scrap metal alone, until silver rises about tenfold in price, up to, and exceeding, $50/oz.

So, back to the main point. Silver, above ground, is more rare than gold! There is seven times as much gold above ground as compared to silver! Amazing! Remember that. Tell others. Shout it from the rooftops. Wear it on a street sign downtown, followed by the words, "the end of your financial world is near!"

What else is different? Well, how did we come to this odd situation where silver above ground in refined form is more rare than gold? We have consumed the silver! Silver is used in electronics, photographs, and jewelry. The largest use is in electronics, and that is growing all the time, perhaps 40% of annual demand is from electronics. Silver is the greatest electrical conductor, better even than gold! Silver is used in switches, because it does not spark, and makes a great contact. Silver is used in bearings and some batteries. When used by modern industry, silver is used in tiny quantities. So tiny, in fact, that most silver used is not economically recoverable. It ends up in the dumps, in smaller quantities than can be mined or refined. Not only is the silver unrecoverable, but the demand cannot be stopped by higher prices. Silver is used in such tiny quantities, and in most cases, there is no substitute.

What is really odd is that the world has seven times as much refined gold as silver, yet silver is still cheap compared to gold: 60 ounces of silver being the equivalent to an ounce of gold. An impartial observer might may view those figures and conclude that a maximum price for silver would be seven times more valuable than gold!

But how much gold and silver is there in the ground? In the ground, gold is more rare than silver. The historic ratio is about 15:1, meaning 15 ounces of silver were worth about one ounce of gold, and this ratio was very close to the ratio at which the two were mined. About ten to fifteen times as much silver was mined as gold. Today, less silver is mined.

Today, since silver is so much cheaper than gold, it is much less economical to mine and sell silver. Today, the world mines about 2,600 metric tonnes of gold per year (according to gold.org), (83.6 million ounces) and mines about 586 million ounces of silver (the 2002 number according to silverinstitute.org). Thus, the world mines about seven times more silver each year than gold. An impartial observer might view those numbers, and conclude that a minimum price for silver should be 1/7th of the gold price, not 1/60th of the gold price. Then, taking into account current refined supplies, that there is seven times as much gold in the world as silver, silver should be worth much more than that.

So, how did the current price ratio develop? What were the forces that created this opportunity of low priced silver that exists today? This is a far more difficult question to answer, and I'm going to have to rely on my opinion and expertise at this point to help answer it.

The main reason that gold and silver are both relatively cheap, is that gold and silver are no longer being used as money in daily transactions by the general population or anywhere in the world. Before the world went "off the gold standard", many economists wrongly predicted that the price of gold would immediately drop, since it would no longer be used as money. The reduced monetary demand, they assumed, meant that the price would drop. They were proved wrong almost immediately, as gold moved up from $35/oz., in 1971 to over $850/oz. by 1979. The economists were proven wrong because people back then recognized the real situation--that dollars were defaulted contracts and fraudulent pieces of paper. But ultimately, the economists were proved correct as seen in the prices today. Today, few people own gold and silver, and most people have forgotten the essential reasons why gold and silver are money.

How little monetary demand is there? Today, there is not a single nation in the world where the people with bad credit use silver in daily transactions. Today, there is not a nation in the world on a gold standard. Today, it is a battle to even get the silver miners to recognize what their shareholders want: that it would be useful for silver miners to hold their money in the form of silver. Today, investors are continuing to sell silver to help meet the gap between mine supply (590 million ounces) and total demand (900 million ounces) (the bulk of the gap is met through recycling).

My opinion is that monetary demand for silver cannot go down from this point, it can only go up.

As I said at the beginning, gold is useful because it is valuable, and because of its other properties. Other commodities are not as useful because they are not as exchangeable or portable because they weigh too much given a similar value, such as oil, zinc or copper. Or other commodities are not as useful as a long term store of value because they spoil, such as food. Or other commodities are not as useful because they are not fungible, and have a higher price range between the buy and sell price, such as diamonds.

The high value of gold makes gold more useful, and thus, more desired, and in greater demand. The greater demand also causes a greater value! Although it is a circular answer, a circular argument, it is also explainable as a positive feedback loop in real life. It works because there really is no substitute for gold as money. (But in many industrial applications, there is also no substitute for silver!) And silver is also money. So why is gold more valuable than silver? It's more valuable because it is more valuable. I know, it sounds like such a bad answer, but how else do you explain it? If you want to "store value", and if you have a lot of money, you'd pick the most convenient form, that which weighs less. And what if everyone else picks gold, too? Then there is increased demand for gold, and reduced demand for the nearest real alternative, silver. The problem is that a lot of the world's gold has ended up in rather large hoards, owned by the central banks. Banks prefer gold over silver, because a large supply of silver is rather heavy and bulky and more costly to store, by comparison.

When the world was using gold as money, banks really disliked silver, and have tried to prevent the use of silver as money. Their reason is that if silver is prevented from being used as money, it reduces the money supply, and thus, makes their gold more valuable by comparison. And also, the banks don't like to have to process and store the heavier silver.

But the weight of silver is also an asset and a key benefit of silver! Large hoards of gold are simply never stolen, because the logistics of the theft make such nearly impossible. I know many people may have seen the movie, "Die Hard with a Vengeance" with Bruce Willis. His character, John McClane, foils the theft of gold from New York's gold vaults. In the movie, only 13 dump trucks were required, and the theft requires the diversion of a bomb threat. It is said that Director John McTiernan acknowledged the errors concerning the gold in the dump trucks and its respective weight. The entire plot is based on the idea that they're going to steal $140 billion dollars worth of gold. At a gold price of $300/ounce, that's about 466 million ounces, or 14,500 tonnes of gold. There's no way trucks can carry over 1,000 tonnes each. The load capacity of a single dump truck is only about 5 tonnes each, or 10,000 pounds. The load capacity of a large moving van is about 3000 pounds. Thus, it would require 2,900 dump trucks, or almost 10,000 moving vans, not 13 trucks! It requires the invasion of an army to steal so much gold, or massive deception on a grand scale, such as getting all of society to look the other way, to paper money, to steal so much gold.

And if it is that difficult to steal gold, due to the weight, how much more difficult is it to steal silver? If you have $1,000,000 in silver, at $10/oz., that's 100,000 ounces. That's over 3 tonnes, or over 6,000 pounds. The weight alone makes silver safer from theft! A billion dollars of silver, at $10/oz, is therefore over 3,000 tonnes, and would require 600 dump trucks to move, and thus, is relatively safe.

The high price of gold compared to silver makes more sense if you simply do not know about the supply and demand fundamentals, or if you have high storage costs that you wish to avoid, or if you are a central banker. It makes sense if you are doing what everyone else is doing, and if you think you have the power to force the entire world to follow your actions. It makes sense if you are a trend investor. The trend investor thinks the prior unsustainable trend will continue, and that gold will become increasingly more valuable, while silver will become increasingly less valuable.

The high price of gold compared to silver does not make sense if you are a value investor. The value investor realizes that something is wrong, that conventional wisdom is wrong, that central bankers are wrong, that the world's leaders are wrong, that the world's most wealthy people are wrong, and that silver is seriously undervalued as compared to gold. The value investor realizes that the central bankers and politicians are not in control, because gold moved from $20/oz to $35/oz back in 1933, and because gold moved from $35/oz. to over $850/oz. in 1979, and silver hit $50/oz in 1980.

The value investor rightfully asks himself, "How can silver become less valuable than today's prices, when it is in short supply above ground in refined form, and when more silver is consumed each year than mined, and when there is already less than zero monetary demand due to irrational investor selling?" It cannot go down! The trend cannot continue. It must reverse course. True value must assert itself. And when true value is restored, which is partly determined by the fundamental factor of scarcity, and people recognizing that scarcity, which is what made gold more valuable than silver in the first place, then perhaps silver will be more valuable than gold! Perhaps such conditions will last for an entire generation, or at least until the above ground supply of refined silver exceeds that of gold!

The value investor will also benefit as the trend investors realize the truth, but a bit later. As silver outperforms gold, and moves up in value faster than gold, the trend investors will tend to jump on board the new trend, and buy silver in preference to gold. Later, the trend investors will be preaching the same things that the value investors know today: that in above ground refined form, silver is more rare than gold, and more silver is consumed by industry than is mined each year!

I find the differences between trend investors and value investors, within people, almost as fascinating as the inherent differences between silver and gold!

The most peculiar thing about trend investors is that they tend to buy a thing when the price moves up to a new high. They call a new high price a "break out", because the price "breaks out of a range" or does any number of peculiar things on a pattern on a chart. For example, it might break out above a flag formation, or break out above a teacup formation, or break out above a head and shoulders formation. The interesting thing about the silver price right now, is that on a ratio chart, we see one of these patterns developing--a "break out" after what looks like a little flag. For months, silver has been trading in a range of around 65 ounces of silver to one ounce of gold. (The inverse is .01538, meaning one ounce of silver is worth about .015 of one ounce of gold. Recently, silver broke out of this range to a new high, as it crossed below 60 ounces of silver to one ounce of gold. (Inverse, .01666). Take a look at the one-year silver/gold ratio chart: