The Mystery of the Gold Silver Ratio
Is there any rhyme or reason to the millennial old relationship between gold and silver? For centuries it was decreed that about sixteen ounces of silver had the purchasing power of one ounce of gold. This was set by way of acknowledgement to the supply and demand fundamentals of the time as well as an attempt to impose some stability on the situation.
It got me thinking in this almost freely floating market of today as to what the various types of gold to silver ratios are saying today. Do they say anything at all or nothing at all in regard to that old monetary ratio?
We have quite a few gold silver relationships we can look at in the world of precious metals. First there is the ratio of the gold to silver price in the fiat currency of choice. According to the last London PM fix, the ratio was 56.1 for the US Dollar and 56.2 for Pounds Sterling and the Euro. Needless to say, this price ratio has jumped about a bit. In fact, it has ranged from 100 to 15 over the last 100 years.
Meanwhile, those companies who fix the gold and silver prices in London transact huge volumes of gold and silver deals under the aegis of the London Bullion Marketing Association (LBMA). According to their most recent statistics, an average of 164.3 million silver ounces and 25.8 million gold ounces were cleared on a daily basis in June. This gives a ratio of 6.37 to 1.
So to start off with, we have two ratios that are nowhere near the old monetary ratio of 16. But as we delve further, some things begin to get a bit more cohesive.
Looking across the Atlantic to the COMEX warehouses, the ratio of silver to gold inventories as of Monday was 12.24. Not too far from our historic ratio. In fact, it would be closer to 16 if it has not been for the rather rapid draw down in COMEX silver in recent months as metal heads over to the Silver ETF vaults. This ratio has been dropping from a value of 17.8 on the 3rd January and sees no end in sight at this point. Nevertheless, we have an approximation to the old value here.
Meanwhile, the paper contracts as reported by the CFTC Commitment of Traders Report for the 25th of July showed an open interest of 97,539 silver contracts each of 5,000 ounces while the gold open interest was 315,635 contracts each of 100 ounces. Add all that up and you get a futures gold-silver ratio of 15.45. Getting even closer to the old ratio!
We also notice that the popular e-gold website www.goldmoney.com reported its last holdings on the 3rd July 2006 as 176,620 ounces of gold and 2,666,445 ounces of silver. Dividing these two gives us a ratio of 15.1. How pleasantly conformable all these numbers are getting to be! Perhaps the old ratio is alive and well though hidden in the markets of today?
Meanwhile, at the government end of things, the US Mint has been producing gold and silver eagles for some 20 years now. The 2005 mintage numbers show that 444,574 ounces of gold were used in the manufacture of all coins from the 1-ounce down to the 1/10-ounce. For silver eagles, it was 8,891,025 ounces giving a ratio of 19.999. I guess the US Mint was aiming at a ratio of 20 to 1 or was this purely customer driven?
Be that as it may, mintage numbers seems to be a moving target with the US Mint as they revise them. Also, gold eagle demand can shoot ahead of silver eagles as we saw in the run up to Y2K when the ratio was driven down to 3.6. I always thought you got overstated or understated numbers from bureaucratic entities!
We could go on, I was tempted to check the flow of gold and silver auctions on eBay but when I saw that there were several thousand open items ranging from 1 to 500 coins per auction, I hope you understand when I say I backed off from that arithmetical nightmare.
Well, so much for man-made inventories, what about the metal ore deposits still underground? According to the last report from the US Geological Survey, the known gold reserves worldwide were 42,000 metric tons and a reserve base of 90,000 tons.
For silver, the world reserves were 270,000 tons with a reserve base of 570,000 tons. This gives us a gold-silver reserve ratio of 6.43 and a reserve base ratio of 6.33. It seems that nature's reserves don't want to play ball with man's reserves above ground! Why the big difference?
On a related subject, world production of gold in 2005 was 2,450 tons and for silver it was 20,300 tons giving another ratio of 8.29. If the production ratio is higher than the geological reserves ratios, that tells me that silver is being pulled out of the ground faster than gold! As an aside, here is the historical ratio of gold to silver global production since 1900. Note how the ratio started near our monetary ratio before a steady long decline.
As it turns out, looking back a hundred years or so can be instructive. If we look at the ratio of all gold and silver ever mined, we have 152,000 tons for gold and 1,336,000 tons for silver. This gives a ratio of about 8.8, which is close to the production ratio.
However, in 1900 that ratio was 14.9 and over the last 100 years we get this cumulative production ratio:
Historically there was a time when geological output (both cumulative and annual) matched the monetary ratio. Was this an effect of human policy or just geological constraints? Which brings us to the main point; we have noted that in the dealings of men, that there is a tendency for gold and silver numbers to gravitate towards the old monetary ratio of 16. It's not perfect across the board but it is there.
The two puzzles are why the geological ratio is half the size of the man-made ratios and why is the current price ratio of 56 even more out of whack?
One thing we may surmise is that when gold and silver are "on the move" as in the LBMA and mine production numbers, the ratio is low. However, when the gold and silver are relatively "static" in various repositories or in paper form, the ratio is more aligned with the old monetary ratio. We note that gold and silver held in these places are more likely to have a monetary component about them.
Aside from the possibility of depleting geological reserves, another reason why the geological ratios may be lower than the past may be simply due to the changing demand profile for gold and silver. The coinage components of gold and silver have significantly dropped across the world since World War II while other new forms of demand have come in to fill in the void and more.
This shifting pattern of demand has apparently caused the historic production ratios to drop from the monetary ratio to one that we may call "commodity-oriented". Granted there is still a component of demand that can be called "monetary" but the shift to industrial applications in the case of silver is obvious. For gold, the investment/monetary component is still more preserved although increased jewelry demand has had the greatest influence on why people buy gold.
But could this in any way explain the large 56 to 1 ratio in the gold and silver prices? Should it make more sense that the geological ratio of 6.33 sets the current silver price at $102 or the 8.8 production ratio to set it at $74? Or why shouldn't the ratios of close to 15 we have seen in human inventories set the price closer to $43?
The truth of the matter is that the markets set the price. We can talk about price suppression schemes and so on, but if we are seeing a ratio close to 15 to 1 in these inventories and futures contracts, does that suggest that there is in fact a "natural" level in operation?
It is not the amount of gold or silver in motion in the LBMA markets or static in COMEX inventories that matters, it is how much people are prepared to bid up for these metals that matters. In this light, I recall an article I wrote recently on the iridium markets. Iridium mining output is only a few tons a year, yet at $400 an ounce it is 38% cheaper than gold which is mined out of the ground by the thousand of tons a year.
Why isn't iridium much more expensive than gold? After all, is it not rarer? As we can see, it is not just rarity that matters but usefulness and utility. Gold has many attractions that bid up its price; iridium is only useful for hardening the tips of ballpoint pens.
Likewise, although silver is about six to eight times more abundant than gold; the current perceived utility for silver sets it a price 56 times cheaper than gold. However, when fear of systemic failure in the global markets is heightening, items such as silver gain a new utility and use as a safe haven asset and new demand appears. When that happens, we expect the gold-silver ratio to approach 15 again. Just as it did when a fiat money collapse was last envisaged back in the inflationary era of the 1970s.
The issue of how much gold is left to be mined is discussed in the next issue of New Era Investor. Please go to www.newerainvestor.com for more information.
Comments are invited by emailing the author at email@example.com.