Money, Markets, and Metals
 

WHY SILVER WILL OUTPERFORM GOLD 400% &
HOW YOU CAN JOIN THE PARTY

By Franklin Sanders
© 2006, The Moneychanger
www.the-moneychanger.com

Abstract:  Over the course of the present bull market in silver and gold, probably another 10 years, silver should rise about four times as fast as gold.  That forecast arises from silver’s historic performance, especially during the 20th century, as well as its present fundamentals.  The best way to profit from that trend is to swap back and forth from silver to gold with the rise and fall in the gold/silver ratio.  That strategy will convert a sterile investment into one that pays dividends, and possibly double the ounces you own over the life of the bull market.

GOLD vs. SILVER

Alas, poor silver is the Rodney Dangerfield of precious metals – it can’t get no respect.  It certainly should merit respect, since its 20th century performance has far outpaced gold.  It’s volatility and superior fundamentals ought to make it much more attractive than gold.

The fact is, gold bugs (with their blind, monomaniacal devotion to gold) miss the point.  They are so ideologically wedded to the yellow metal that they overlook both history and facts.  It is not a monometallic gold standard that history overwhelmingly demonstrates, but bimetallism.  Shortly after I wrote Silver Bonanza for Jim Blanchard in 1993 but before it had been published, Jim teased this gem out of Nobel Laureate economist Milton Friedman:  “The major monetary metal in history is silver, not gold.”  (I remember it well because the statement struck Jim so strongly that he had it printed up on a sticker and inserted it on the flyleaf of the original 8-1/2 by 11 version.)  Friedman was right, of course.  For most of mankind throughout most of history, silver has been the much more important monetary metal, familiar as the metal of daily commerce.  Gold was used only for very, very large payments, which most people make only rarely, if ever.

Both silver and gold are monetary metals, i.e., they both benefit from monetary demand.  (Monetary demand is also called “investment” demand.  It is demand for silver as silver, and as an ingredient making something.)  Most analysts miss silver’s monetary demand because they focus on silver’s use in industry.  Certainly, since silver was politically demonetized beginning in the mid 1870s a vast amount of purely monetary demand disappeared.  Today, most silver is used in fabrication, roughly split three ways among silverware and jewellery, photographic, and other industrial uses.  But when confidence in central bank issued fiat money begins to fade, when fear strikes investors’ hearts, they run not only to gold, but also to silver.  Especially in America.

That demand profile makes monetary demand for silver more important, not less.  Why?  Because all of that monetary demand hits silver at the margin.  Fundamental demand changes only slowly, but monetary demand comes out of nowhere, adding huge, insistent demand for silver at the margin.  Because the silver market is so much smaller than the gold market, a new dollar invested in silver also has a much greater affect on the price.  That makes silver more volatile than gold, which wears on your nerves but swells your profits.

Be advised, I am not arguing for investing in silver only, but rather for a more subtle strategy.  I want to show you a way to invest in BOTH metals, swapping them back and forth at the appropriate time, possibly doubling your return over the life of the bull market, which is probably another 9 – 10 years.

When I began musing over this article, the gold/silver ratio was hovering around 60 (it took 60 ounces of silver to buy one ounce of gold).  By the end of this bull move, I expect that ratio to drop to 16:1 (16 ounces of silver will buy one ounce of silver).  In the meantime, the ratio will zig and zag, and we’ll take advantage of those moves, too, by trading the ratio.

THE ONE GREAT SECRET OF INVESTING

There is one Great Secret of Investing that you must not ignore:  always invest with the primary trend.  Look at Chart 1, SILVER, 1963 – 2006.  It offers a good picture of a primary uptrend (“bull market”) and a primary downtrend (“bear market”). 

What is the primary trend?  Like the tide in the ocean, the primary trend is the long term -- 10 to 20 year -- move where the general trend is up or down.  Just as you wouldn’t want to try to launch your boat against the tide, you never want to launch your investment boat against the primary trend.  Within that trend, like waves on the tide, are zigs and zags up and down.  We can also ride these waves to profits, but must be much more careful with them since they move so much faster.  Our strategy keeps your money invested with the tide, but takes advantage of waves on the tide as well.

Stocks’ primary trend turned up in 1982.  Without exercising a great deal of discriminating brain power, you could have bought almost any stock in 1982 and made huge profits by 2000.  How could you have helped it?  Measured by the Dow Jones Industrial Average, stocks rose 12,000% over that 18 years.  A rising tide lifts all boats, even the garbage scows.

Likewise, it makes no sense to buy stocks now.  A primary downtrend (“bear market”) commenced in 2000, and it must work itself all the way to exhaustion.  That process will take from 10 to 15 years, and not even the almighty Federal reserve creating tidal waves of money out of thin air will keep the stock market up.  The rule of thumb says that a bear market will give up 50% to 95% of the foregoing bull market rise.  Do the math, and you will come to a Dow target of roughly 6,000 to 1,250.  Do you really want to buy stocks now, and hang around for Dow 6,000?  Or Dow 1,250?

IS SILVER IN A PRIMARY UPTREND?

First we have to answer this question:  Is silver in primary uptrend?  Let’s look at the charts.  Chart 2,  Silver, 1998 – now, cents per ounce, shows a very long, rounding bottom.  This formation is typical of bear market bottoms, and very reliable.  Not only did silver emerge from that rounding bottom in an uptrend, it has also now burst through the top of that uptrend.

Now look at Chart 3, Silver, January 1979 – June 2004, arithmetic scale.  Again, notice the long rounding formation beneath $8.25 resistance.  For about 20 years that $8.25 resistance turned silver back time and again.  You can see that in April, 2004, when silver first touched that line, it fell back back, correct and them challenged $8.25 again. When it finally broke through $8.25, it ran away to the next resistance at $15.00.

Comparing silver’s performance to stocks’ over the last 6-1/2 years offers us another witness that silver is in a primary uptrend.  Chart 4 shows Stocks versus Silver, 8/25/99 – 5/3/06.  The little flat pancakes (and drooping slag-sickle) on the left show how various stock indices have performed.  The towering stacks on the right depict the performance of silver & gold.  While stock indices have dropped by as much as a third, or done nothing at all, gold has risen 150.3% and silver has risen 169.2% (2.69 times where it began). 

Lest I be accused of bias, let’s see how silver and gold have performed against some other investments.  Look at Chart 5, Investment performance as of 30 April 2006.  Only the HUI, the unhedged gold stock index, has outperformed silver in the last one, three, or five years.  What about the Dow, the S&P 500, and the US Dollar Index?  Silver has left them in the dust.

HISTORICAL OUTPERFORMANCE

If I had a chart 45 feet long on which every foot represented 100 years of human history, the gold/silver ratio would remain under 16:1 for all but the last 15 inches.  In fact, for the first 40 feet (until about 1500) the ratio oscillated under 12:1, and spent most of its time between 8:1 and 12:1.  Only after the discovery of huge silver deposits in the Americas does the ratio begin to climb above 12:1.  I can only speculate about the reasons for the ratio’s relative stability.  Probably it arises from the relative ratio of silver to gold in the earth’s crust, which geologists estimate at 17.5:1.[i]

BIMETALLISM & ALL THAT HOGWASH

Reading the standard economics and history texts you would think that bimetallism led the 19th century into a riot of monetary confusion, but that is hogwash.  It wasn’t bimetallism, but state action that caused the problem.  Rather than following the market ratio (as the US monetary system was designed to do) England and France set their official mint ratios at different levels, so whichever metal was temporarily cheaper in one country would drain out to the other country.  This chronic misevaluation tended to drive out of circulation the more under-valued metal – generally silver.  After about 1815 the ratio began to fall (silver gained value against gold).  Though small by today’s standard, that drop sped up in the 1830s and 1840s as huge new gold deposits were discovered in Carolina, Australia, and California.  The price of silver in gold dollars ($1.00 in gold = 0.048375 troy ounce) rose from $1.29 in 1848 to 1.35 by 1857[i] (the ratio fell because it took fewer ounces of silver to buy an ounce of gold).  Silver’s rising price forced the US to make its fractional coin (half dimes, dimes, quarters, halves) subsidiary.  Since silver bought more gold as bullion than at its face value, speculators were melting the small silver coin.  Dollar coins had already disappeared.  Congress reduced the silver content of the fractional coin by 6.5% (from 0.7734 ounce per dollar to 0.7234 ounce) just to keep small coin from disappearing.

So the cause of the bimetallic problems was not a rising supply of silver from the Comstock Lode (the red herring usually trotted out), but a rising supply of new gold.  More disruptive than that, however, was the policy of setting official mint ratios politically rather than following market determined prices.  After the US demonetized silver in 1873, followed shortly by Germany and other nations, the ratio of course rose.  The loss of monetary demand for silver sharply reduced overall demand, and therefore price, although silver didn’t fall as quickly as you might expect. 

Chart 6, Gold/silver ratio 1792 – 2005, yearly averages, shows how the ratio behaved during two centuries.  What interests us most as we try to devise an investment strategy is the pattern.  The ratio trades in a range, with tops at 100:1 separated by 50 years, and bottoms at 16:1 or lower in 1919, 1968, and 1980.