At the time of this writing, the gold to silver ratio is approximately 66 to 1. While not the largest variance between the two metals, it’s over four times higher than the gold to silver ratio established by Congress in 1792 of 15 to 1, nearly four times as high as the 17:1 ratio briefly seen in 1980, more than double the ratio experienced in April 2011 of 31 to 1, and substantially higher than the average ratio seen in the 20th century of 47 to 1. In this article, we’re going to address some of the historical ratios that we’ve highlighted above and will provide three reasons why we believe that the gold to silver ratio will likely contract from its current ratio of 66 to 1.
Before we delve into a discussion on future gold to silver ratios, it’s important to take a look back at where we’ve been. Many silver bulls point to a historical gold to silver ratio of 16 to 1 when making the case for silver. While we believe that silver is an excellent investment and highly recommend it, we are of the opinion that it is misleading to inform investors that the gold to silver ratio will contract to these levels. For one, when the gold to silver ratio of 15 to 1 was passed into law in 1792, this was a fixed rate established by the government. As we saw when the price of gold spiked 43% in one year following our removal from the gold standard in 1971, fixed rates aren’t necessarily indicative of free market values. As to the comparable ratios we experienced in 1980, this was due to the Hunt Brothers cornering the silver market. The price of silver skyrocketed to $50 an ounce, only to plummet following the change of COMEX’s margin requirements and an increase in interest rates by the Federal Reserve.
While we believe it’s highly unlikely that we’ll see 15:1 gold to silver ratios anytime soon, the first reason we believe that the gold to silver ratio will contract from its current levels is due to current mining output. On average, approximately 700 – 800 million ounces of silver is mined per year. According to the Silver Institute, 787 ounces of silver was mined in 2012. This compares to annual gold production of roughly 2,500 tons, which translates to approximately 80 million ounces. Considering that annual silver output is roughly ten times that of gold, we would expect for the gold to silver ratio to shrink from current levels, simply due to the availability of the two metals.
Use & Availability
While the annual gold to silver production may be surprising to most folks, it doesn’t tell the entire story, as approximately 50% of silver is used for industrial purposes and is not recoverable. This is in contrast to gold, which has limited industrial use, at approximately 10%. Considering that most gold that has been mined throughout history is still available and above ground, and approximately 50% of silver is lost annually, the ratio of available silver to gold is roughly 5 to 1. At this ratio, even the above historic ratios of 15 to 1 sound low; however, investment demand for the two metals differs substantially, which is the primary reason for the over weighted gold to silver ratio.
In order to close the gap between gold and silver, investment demand must increase from its current levels. According to Gold News, coins and medals accounted for 9% of silver use in 2012 and net investment accounted for 15%. This is in contrast to gold investment demand of 40%, according to Wikipedia. However, Wikipedia’s estimate is likely low considering China’s record level gold imports in 2013 and strong demand from Central Banks; especially those from emerging markets. While 2013 was a banner year for the sale of American silver eagles, with roughly 43 million troy ounces sold, as we reported in a previous piece, increased and consistent investment demand is needed for the price of silver to increase relative to gold. One factor that should help to bolster investment demand is increased interest in gold and silver in China and India. While gold historically has been the metal of choice for these nations, we’ve seen an increase in demand, especially from India, where the government has imposed high import taxes on gold. Continued strong global demand, especially in the Far East, should help to push up the price of silver.
In summary, while it’s highly unlikely that we’ll once again see gold to silver ratios in the 16 to 1 range, it’s possible, and quite probable that the current ratio of 66 to 1 will contract over time. This is due, in part, to the annual production of gold versus silver, the percentage of silver that is lost annually due to industrial uses, and increased investment demand, both in the U.S. and abroad. The most important factor is global investment demand, which should help to reduce the volatility of silver, and result in the out performance of silver during the next gold and silver bull market.