Sunday, November 14, 2010

Gold-Silver Ratio breaks 1:50 level as things get interesting

Back when the US had a gold and silver standard, the dollar was pegged to gold, but silver was also pegged to gold.  This gold-silver ratio was held rather steady at about 1:15, meaning that one ounce of gold would buy the holder about 15 ounces of silver, or vice-versa.  

This gold-silver pegging was reflected in the dollar right up through 1933: before the illegalization of private gold ownership thanks to a conspiracy between the Federal Reserve, Congress, and FDR in 1933, it was a given in US commerce that twenty $1 silver coins were interchangeable for one $20 gold piece, which contained just under 1 oz of gold.  As US dollar coins were minted with 0.7734 oz of silver in each, this maintained the ratio of almost exactly 1:15.5.  Let's check this out visually:  

The Gold Confiscation Act of 1933, of course, threw everything you see above out the window.  Not only were you not going to get gold coins for your silver coins, as it was now magically illegal for the meeeeeasly American citizens to own gold coin, but you certainly were not going to get an ounce for $20: nope, even assuming you'd like to break the law to get your hands on some, you'll have to pay a whooping 75% more than you ever had--a nice $35 for an ounce.  Instantly, with the stroke of FDR's pen authorizing the Gold Reserve Act of 1934 and the revaluation of gold to $35 US dollars per ounce, the 160-year-old American standard of a 1:15 gold-silver ratio that had been a feature of the US dollar since the beginning of the Republic, was gone.  Just that quickly, the ratio had moved to nearly 1:27, or a matching increase of 75%.  Now, assuming you could get the Gaudens (which you could only do on the black market if you could do it at all, and which would have been subject to immediate confiscation if any federale found out that you had it), you couldn't bring home the Gaudens for 20 Peace dollars, but rather, you had better bring 35.  Or, to compare:

Not to mention, you had to deal with gangsters!   Yikes! (Is that one in the middle Obama?)

Of course, as covered in other posts, eventually the dollar was totally detached from silver by 1964, and has become so worthless that 29 years ago in 1981, it was even detached from copper! So, I supposed right now we are on a "nickel and zinc standard," but we have already lost the "nickel standard" part, as the coins we call "nickels" are 75% copper and cost more than 5 cents to make.  Or actually, to express the phenomenon more properly, our dollar is so devalued that it cannot buy a nickel for a nickel.  As for zinc--zinc is currently at $1.10/lb, and is up over 100% on the year, so soon we won't even be able to afford to make pennies, as those coins are 95% zinc.  This is the effect of fiat money--it is designed to made worth less and less!

So, getting back to the gold-silver ratio, where do we stand today?  The average since 1971, when the dollar was divorced from gold, has been around 1:55 to 1:60, with a dip to below 20 (during the Hunt brother's silver scheme) to a peak of 1:100 about twenty years ago in 1991.  What is interesting about the first--the dip below 1:20 that occurred during the Hunt brothers silver spike--is that even at its lowest, the ratio did not reach the pre-1933 standard of 1:15.  Even at its lowest, the ratio was 25% higher than the average for the entire period of American history (and indeed, world history) prior to 1933.  

As for the peak at 1:100, I'm rather quite enjoying this visualization thing, so here is that distortion in Peace dollar terms.  Using Peace dollar terms, this was just under 130 Peace dollars for one Gaudens, which looks like this: 

And it would have been a steal of a the reverse!  Those who exchanged that Gaudens for 100 ounces of silver in 1990 would have done better than those who didn't.  At the time, gold hit a multi-year peak of just over $420/oz, while silver staggered down to $4.2o/oz.  Assuming that someone had just wanted to trade-and-hold, a silverbug who traded an ounce of gold for 100 oz of silver would be looking at a 566% return on the silver.  Conversely, the other guy who took the gold over the silver would have a still impressive, but much smaller, 238% return, based on last weeks average prices of $1420/oz gold and $28/oz silver.  

It is a strategy of some metals investors to trade gold for silver and silver for gold based on the gold-silver ratio.  The interesting event that has occurred recently with this rally in gold and silver is that silver has convincingly broke through the 1:60 mark and, as of last week, the 1:50 mark.  Not too long ago, in early 2009, major weakness in silver was percieved due to the 1:82 level, but that was obviously short-lived.  But as I write this on Sunday night, with Asian trading now open and gold at $1,372/oz and silver at $26.37, the ratio tonight is back over 1:50, up to 1:52.  Or, 1:67.5 Peace dollars worth of silver...

One last thing to remember the with gold-silver ratio.  When the spread increases, that is, when the number gets bigger (as the gold side is always just "1"), you are seeing a greater move in gold  relative to silver; or in other words, gold strength.  Conversely, when the spread narrows (when the number decreases), you are seeing a stronger move in silver; that is, silver strength.  Many have speculated as gold increases in price, silver will appear "cheaper" simply because it won't have so many zero's behind it.  If this does indeed occur and investors move into silver as a result, the gold-silver ratio will obviously reflect this, and the spread will tighten.  Given the long term history of a centuries-old 1:15 ratio, silver looks cheap right now.  But given the average since 1971, silver actually looks a little overbought right now.  And no, I have not overlooked the massive SLV ETF move last week--the record-breaking silver ETF that added 352 tonnes overnight--as this obviously was a factor in breaking the 1:50 level, and came on the heals of a $2 price dip.  At that time last week, when silver hit a high of over $29 just before the COMEX rule change, the ratio dipped to a nearly unheard-of 1:48 mark, and was followed up by a massive support move that held the $27 level.

So, we shall see where we go from here.  Don't forget about the dollar in all of this: USD is knocking again on its all-time lows as per USDX.  Nothing comes for free: your silver and gold are getting more valuable because your US dollars are getting more worthless.  Just like the Chinese curse, we live in exciting times, indeed.  And I haven't even mentioned what Mr Zoellick at the World Bank said last week...

(Note: Please understand that my use of Peace dollars is for historical perspective only, as they really used to be exchangeable for Gaudens.  In today's market, you would want to use bullion for this, as that is what the ratio is based on.  Peace dollars have a slight rarity value that carries their average price higher than spot, and they are also more expensive than regular junk silver.  Likewise, a Gaudens is a limited-production coin, and many are numimastic and thus carry a premium as well.  My calculation with the number of Peace dollars relative to a Gauden are, as I mentioned above, based on the 0.77 oz silver per coin recognized content, and pretending that we still have an exchange system like what we did in 1933.)

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