The Gold/Silver Ratio

Tracking and trading the ratio of gold to silver prices...

THE FOLLOWING is an interview I recently did discussing the Gold/Silver Ratio with Tom Jeffries at Howe Street, writes David Morgan of Silver-Investor.

Tom Jeffries: You talk many times in your lectures, and you've talked in The Morgan Report recently, about something called the Gold/Silver Ratio and where it's going. Can you talk a little bit about that?

David Morgan: It is a controversial subject. There are a lot of people who don't put any credence into the ratio of silver prices to Gold Prices, there are some people who put a whole lot of credence into it, and then there are people, like me, who absolutely put some credence into the Gold/Silver ratio.

The basics of it are this – and I like to go for the long-term version, so – starting at the 12th century or so and going to present time, if you looked at every one foot in length being 100 years (or one century), you would see throughout the entire timeframe that you would have several feet in length and it would only be in the last 19 inches of that chart where the ratio of gold to silver prices got above 16 to 1.

In fact, the ratio from the 12th century to roughly the 17th century was about 12 to 1, which is what I call the "natural ratio" at that time, and I define the natural ratio as the amount of silver to gold in the earth's surface. Right now it's less than 12 to 1, having dropped down to about 8 to 1, which means that there's about eight ounces of silver in the earth's surface for every ounce of gold.

So that's the natural ratio, and that ratio held for hundreds and hundreds of years with the free market making the determination – amazing! Then, Sir Isaac Newton monetized it at a ratio of 15.5 to 1 after England was having a terrible time with their fiat money system. Newton came in and put them on a gold standard and then, with his brilliance, he picked a number basically based on the marketplace (at that time), which determined that the correct ratio of silver to gold was 15½ ounces of silver to 1 ounce of gold.

And that's what we called the monetary of the classic ratio, and that held roughly from the 17th century for hundreds of years through about the 1873 timeframe. Then there was The Crime of 1873, which we don't have time to go into, but that was roughly where silver was demonetized in the United States, and after that, you've seen the ratio undergo some really wide swings.

It's gone up as far as 100-to-1 a couple of times – with one ounce of gold costing the same as 100 ounces of silver – and we've seen it just kiss the classic ratio of 16 to 1 for a day. In modern times, meaning during the last big run-up in January of 1980, it got back to classic ratio, but again, it was only for a day or two at the most. And then the Gold/Silver Ratio dropped off.

So having given you all that background, what does it mean? For some it means you can trade the ratio, which is something that I do personally. Secondly it's a good indicator for the overall direction of the market as far as I'm concerned. When silver's leading gold – and the ratio is falling – we've got more momentum in the metals than when it's not, and silver has basically outperformed gold since 2003 until recently.

In other words, in the ratio from 2003, the bottom of the silver market, and when gold was at $252 in 2000, silver went from an 80-to-1 ratio down to about 55. Currently it is around the 65-to-1 level. And it was working its way even lower when we had this credit crisis surface, which didn't surprise me. We got a big spike on the ratio and actually it got to around 90-to-1 – again, very temporarily, maybe for a day or two.

I think it shows that silver is still undervalued to gold, but I'm open-minded enough to think that maybe something else is going on. In an absolute all-out deflation, which would be the better – gold or silver? The preponderance of evidence is that gold does better. I wrote a paper on this; it was in The Morgan Report, and I also did a couple of speeches on this subject. The record is mixed as far as how silver does in a deflation.

Gold is pretty much known to do well in deflations, and this is all history. And because it is history, it doesn't absolutely guarantee you that the next time around gold will do great in a deflation, but it certainly implies that it will.

As far as silver is concerned, there have been times that silver did better than Gold Prices in a deflation, and many times where it did not. But overall it's done fairly well and it held its purchasing power, so even in a deflationary scenario I wouldn't give up on silver. But as far as what will it do, if we look at it today we would say gold has actually done better than silver here in the last several months, because the ratio has gone from the 55 to 1 back to around the current 65 level.

Regardless, the overall perspective would be, how is silver doing against all other financial assets, including gold? And the answer to that is, essentially, gold has done best against all other financial assets, the general equities, the mining stocks, housing sector, bonds; and silver has done better than the base metals and most other sectors.

Silver is partly industrial and partly monetary and you can argue all day if it's both or not. I'm absolutely convinced that it's both. I've never argued that silver is just money. I have argued very strongly that silver is money but it's not only money; it's certainly an industrial metal as well.

In summary, if [our readers] think – as I do – that the main problem ahead is a currency crisis with the US Dollar, then I would urge you to study what silver did during the last period (most recent) during a prelude to a currency crisis. Basically, it outshone almost everything! The problem is people are too shortsighted and look out only so far, not realizing that once everyone understands that the death of the Dollar is imminent, there will be a mad rush for the precious metals both gold and silver!

Mr. Jeffries: David, always a pleasure to have some time with you. We really get a kick out of talking with you, but also I also commend you, too, for the learning. We always have some great information.