Could silver be worth as much as gold?
Some might say that it is completely preposterous to suggest that silver could become worth as much as gold. However, there have been episodes in history where this has occurred briefly. It is therefore not impossible. In such a scenario, the gold to silver ratio would be historically low. Could such a low ratio occur again, and if so, what are the factors that could cause this?
What is the gold silver ratio?
When it comes to the gold silver ratio, the first thing we need to clarify is which specific ratio we are talking about. Within the earth, silver is 19 times more prevalent than gold. However, when it comes to extracting the metals, 9 times more silver is mined than gold. These ratios are relatively static. When it comes to pricing these precious metals, two ratios exist and these are dynamic. The physical price ratio is currently 55. Of course when people talk about the gold silver ratio they are usually referring to the paper price ratio which is currently 66 and it is this ratio that I will discuss here.
History of the gold silver ratio
Looking at the history of the gold silver ratio can be informative and we can divide it into four main eras.
The above chart shows that during the bimetallic standard, when both gold and silver were considered monetary metals, the ratio was very stable, averaging 15. The demonetization of silver in 1873 saw a rise in the ratio, with an average value of 30. The end of the classical gold standard saw a huge fluctuation in the gold silver ratio with a range of 17 to 97. The fiat era has seen even larger swings in the ratio, from 15 to 120.
The gold silver ratio in the fiat era
The above chart shows that in the fiat era there are two sub eras where the ratio appears to swing between a roof and a floor. In the inflationary 1970s, the ratio moved between 18 and 48. From 1990 to today, the ratio has mainly swung between 45 and 80, forming a kind of roof and floor.
It has taken between around 2 to 5 years for the ratio to go from peak to trough. We can also see that there are numerous upswings on the way down and the majority of time is spent in the mid-range, with times at the peak and trough values being brief.
What is the gold silver ratio telling us right now?
The first thing to note is that in 2020, the ratio reached a historical extreme high and has since dropped rapidly towards the mean. In fact it has been one of the fastest declines, and the ratio clearly remains in a down trend. History suggests it is likely to spend more time between the 50 to 70 level, before spiking down to it’s ultimate low. It is not clear how long it will take to reach its ultimate low.
This leads us to the question of how low the gold silver ratio could go. The previous chart shows that it is likely to drop to 45 but could it drop significantly lower? Could it break that floor in a meaningful way? In order to answer this, we need to understand what drives the gold silver ratio.
The main driver of the gold silver ratio
The above chart shows the gold silver ratio in black and the gold price in orange. At the bottom in red is the correlation coefficient. We can see that the correlation is rather variable, flipping between positive and negative. There is no consistent relationship there.
However, when we compare the ratio with the silver price shown above in gray, the correlation is strongly negative most of the time. We can therefore conclude that the silver price is the predominant driver of the gold silver ratio.
We can also conclude that a drop in the ratio is associated with a silver bull market. The above chart shows how major peaks in the gold silver ratio have marked the bottoms in silver bear markets (green arrows), and major lows in the ratio have marked the tops of silver bull markets (red arrows). The fact that the ratio is currently moving downwards from a historical peak suggests that silver is in a secular bull market. Also note that every time the correlation turned positive, it was brief and coincided with the start of a large rise in the price of silver (black stars). That signal appeared in 2020. Whenever both a green arrow signal and a black star signal occurred together, the silver price subsequently rose sharply. That occurred in 2020, supporting the idea that silver has entered a bull market.
The driver of the silver price
OK, now that we know that silver is the main driver of the gold silver ratio, is it the industrial or monetary demand that primarily affects the silver price?
The above chart compares the Bloomberg industrial metals index in red to the silver price in grey. The correlation between the two is highly variable, with big swings between positive and negative. Therefore, although over 60% of silver demand is industrial, that demand has a variable effect on the silver price.
In contrast, the above chart shows that the correlation between silver and gold is very strong. This suggests that silver is priced more as a monetary metal than as an industrial metal.
Physical vs paper silver
We know that it is not physical investment demand that drives the price of precious metals, it is the paper derivatives. The silver market is small and volatile and has the highest derivatives to physical ratio of all commodities.
The above chart indicates it would require 160 days of global production of silver to cover the short contracts for silver. For gold it is 90 days. It is likely that the paper derivatives pricing of the metals has constrained the lows in the gold silver ratio over the past 30 years, leading to the observed floor in the ratio. A transition from paper to physical pricing of the metals has the potential to remove that floor in the ratio.
Inflation expectations and the gold silver ratio
Inflation expectations also influence the price of precious metals. Shown above is the inverted 10 year break even inflation rate in blue and the gold silver ratio in green. As inflation expectations rise, the gold silver ratio falls. If we see significant inflation going forwards, particularly when it is felt at the retail level, the floor in the ratio is likely to break.
Silver investment demand
We have already begun to see a substantial increase in investment demand for silver and this has persisted despite the recent drop in the silver price. An increased preference for physical metals in conjunction with increased investment demand has the potential to alter the precious metals pricing mechanism, which could drive the gold silver ratio through that floor.
Silver as a commodity
We have over 2 centuries of evidence showing that commodity prices are cyclical and we have recently come off a historical cyclical low. This would suggest that commodity prices are likely to be on the rise in the coming years. What could spur this? Fiscal stimulus with spending on infrastructure as well as the intended greening of the economy with renewable energy and electric vehicles. Silver is a crucial component for these. How does this relate to the gold silver ratio?
The above chart shows the gold silver ratio in green and the commodities to equities ratio in black. Previously, peaks in both ratios have coincided (yellow circles). But since 2012, the two have diverged significantly. Commodities are at historically low prices relative to equities and the downside seems very limited. If we are at the start of a commodities supercycle, and both the industrial demand and price of silver rises as part of that supercycle, particularly in the face of physical silver supply shortages, that could break the floor in the gold silver ratio.
Returning to the gold silver ratio chart, if we anticipate that the financial environment of the past 30 years is likely to persist, then the ratio is likely to bounce back from the floor in coming years and remain in this range. A sustained break in the floor would signify big changes in the financial and economic landscape.
The current gold silver ratio suggests that the precious metals are in a secular bull market. Due to its tendency to mean revert, the gold silver ratio has further to fall, suggesting that silver is favoured over gold. Before reaching it’s ultimate low, the ratio is likely to spend more time around the mean range. I think that a historically low gold silver ratio is possible.
The reason I say this is that I think there are multiple drivers that could drive the ratio downwards in the years ahead. The paper pricing of the metals appears to have been put under pressure recently as a result of increased demand for physical delivery. If the paper pricing is supplanted by physical pricing, the gold silver ratio is likely to fall. Regardless of whether or not the paper market breaks, I postulate that factors such as inflation, monetary demand and industrial demand have the potential to act synergistically to bring the gold silver ratio down to historically low levels.
Note that this is not meant to represent certainty, it is simply a discussion of potential scenarios. If you believe that the financial environment of the past 30 years will persist, then the gold silver ratio is likely to stay within the current band. However, if changes in the economic environment are expected, then we need to consider the possibility of a historically low gold to silver ratio.