The Gold to Silver Ratio:
A Primer, an Issue, and an Opportunity

Ratios are all around us, though rarely thought about in our day-to-day decision making process. However, if we understand ratios, we can make smarter decisions on just about everything. Let’s consider a simple example of price ratios, and one that takes place all the time. Think back to the most recent Fourth of July, and think about what people enjoyed eating that day. Perhaps fresh corn was on the backyard menu? Ah yes, corn on the cob, a favorite summertime food, either boiled in a pot, steamed in the husk, or caramelized directly on the grill. Few things in life are so utterly simple yet oh-so savory. Picking up a dozen ears doesn’t just taste good, but corn is cheap and a simple price ratio tells proves the inexpensiveness.

Continuing our corny example, no pun intended, buying corn is an easy economic decision that maximizes purchasing power and maximizes the return on that purchase, especially when we compare the dollar price of corn in relation to other produce in the supermarket. Oranges? Kinda pricey come Fourth of July. It’s better to wait till fall/winter when biting an orange causes the sweet sticky juices to flow down the wrist. Oranges don’t really have a place in the backyard summer barbecue, but corn is cheap, plentiful, and the picking is good. The crux of the matter is that the orange to corn ratio is very high, so it is smart to stock up on corn and take advantage of the favorable conditions. Besides, by the time the deep freeze of winter is in full swing, the only corn to be found will be more expensive in price, inferior in product, and require additional “must-have” items just to eat and store, such as a can-opener and a freezer.

Ratios can be applied to make smarter investment decisions too. When we talk about ratios in the precious metals markets, by far the most common ratio is known as the gold to silver ratio. Some people call it the GSR, and most traders, coin dealers, and silverbugs alike all know the acronym. Suffice to say, the gold to silver ratio is nothing more than a simple mathematical calculation, which produces a result that demonstrates how many ounces of silver does it take to buy an ounce of gold?

We know that gold and silver have been used for thousands of years, and we know that gold and silver coins are specifically called for in Article 1, Section 10 on the US Constitution. What some people do not know, however, is what the actual gold to silver ratio was, how it developed over time, and what the number is today. All three of those points are relevant and merit discussing each one briefly, because, the goal is to learn a little more about the metals and the markets. Maybe there is somebody out there who is finally ready to come into our community and buy some gold or silver, but they don’t know which to buy?

Now we would never say “buy this” or “buy that”, because nobody truly knows what is going to happen to any given bar, coin or round, whether it is gold or silver. However, if we see the gold to silver ratio flashing warning lights, and we hear the sirens blaring through the loudspeakers, well, maybe that decision of which metal to buy becomes a little simpler to make. It is best to make an informed decision over a guess, however educated that guess may be, and informed decisions are certainly better over impulse buys, to which one never really gains an understanding of the investment decision making process in the first place.

First, let’s understand the original gold to silver ratio. The Act of April 2, 1792, commonly referred to as “The Coinage Act”, defines our money specifically, and therefore establishes the first ever gold to silver ratio in the United States. The United States Mint has the text of the act online, free for the reading, and it is well worth the read. The document speaks from a time when our dollar was something, well, defined. In fact, an “Eagle” was a gold coin containing 247.5 grains of pure gold with a face value of $10. One dollar was a silver coin containing 371.25 grains of pure silver with a face value of, well, $1. Knowing this, we can calculate the original US gold to silver ratio, that began in 1792. The ratio produced a value of 15. In other words, it took 15 dollars (which is nothing more than a weight and purity of silver) to buy $1 of the equivalent weight and purity in gold.

For nearly 150 years, the value of our gold and silver money held steady. The US Dollar held its value because the United States was on a bimetallic gold and silver standard. That is to say, one dollar was a specific weight and purity of silver, and, curiously perhaps to some, there was even a defined 2 ½ dollar gold coin, called a “Quarter Eagle”, which was a specific weight and purity of gold.

When President Roosevelt “confiscated” gold in 1933 under the auspices of Executive Order 6102, One ounce of gold was exchanged at a rate of $20.67. The executive order culminated a year later with the Gold Reserve Act of 1934. With the stroke of a pen, ordinary Americans were no longer permitted to own gold. The Gold Reserve Act of 1934 was more than just a simple slap on the wrist for those who refused to turn in their gold. In fact, a person owning gold illegally could have been subjected to various forms of civil asset forfeiture. Moreover, fines were allowed to be double the dollar value of the gold that was held illegally by the individual citizen. Section 4 of the Act spells out all the repercussions.

Within 30 years of the Gold Reserve Act and the removal of gold from circulation in the United States, silver was removed from our money as well. Since 1965 (silver coins were minted through 1964), the dollar has been what is known as a “debt-based fiat currency.” This sounds very academic, perhaps by design, but all it really means is that it is backed by nothing except one person’s promise to pay another person (hence debt-based) with the identical or similar promise to pay, and that’s how it was going to be since laws were enacted requiring (hence fiat) the use of the dollar (hence currency) in settlement of payments.

Nonetheless, for many, many generations, the United States had a nice gold to silver ratio of 15. Americans enjoyed stable money with an actual system of weights and measures, as intended, and as such our family, friends, neighbors and colleagues carried little bits of gold and silver in their pockets which were used in their day to day transactions. And while the gold to silver ratio was steady, a problem emerged for gold. In the 1930s, when gold confiscation was in full force. A few decades later, by the mid-1960s, silver was shown the door as well, in favor of the “Federal Reserve Note” we all are forced to use today. Needless to say, the gold to silver ratio has been slowly but surely increasing over the last 75 years while the value of the dollar has been eroding. With all of that monetary action in the United States during our vibrant history, three questions warrant merit for a deeper understanding of the gold to silver ratio:

  1. What is the gold to silver ratio today?
  2. What is the natural gold to silver ratio?
  3. Can the gold to silver ratio be useful in making investment decisions?

We know that the original gold to silver ratio in the United States was 15, and since the calculation is simple, simply dividing the dollar price of gold by the dollar price of silver, there is no way to pull the punch or sugar coat the ratio today. Some readers may want to remain seated if learning about the gold to silver ratio for the first time. Nonetheless, the the gold to silver ratio today is over 77. Notice the following graph of the gold to silver ratio since the global financial crisis of 2007/2008 (from StockCharts for informational purposes only):

The chart is very interesting, because we can understand a few things about gold and silver from looking at one simple line plotted on a graph. First, we can see that when silver was making it’s highs in April of 2011, the ratio dropped all the way down to 32.01. In other words, at the peak in 2011, it took only 32 ounces of silver to buy one ounce of gold. Since 2011, the gold to silver ratio was increasing rather linear, until early 2016. Recall that in December of 2015, as the prices of gold and silver were bottoming, the retail physical silver market was tight, and the US Mint even had American Silver Eagles on “allocation”, which is a fancy way of saying “rationing”. Gold and silver both made nice recoveries through the first two-thirds of 2016, and as such, the gold to silver ratio fell last year, until the second half of the year. After some months of choppy consolidation in the ratio, since the start of 2017 and continuing today, the gold to silver ratio has resumed the upward trend, and now it takes over 77 ounces of silver just to buy one ounce of gold.

We know what the original gold to silver ratio was historically, and we know where it is today, but since so much monetary policy has been implemented over the last 241 years, what could we consider a natural gold to silver ratio? In other words, is 77 too high of a number? The answer to that question is easier to calculate than one might imagine. One way to calculate a natural ratio for the real world is to divide total global mine supply of silver by the total global mine supply of gold. This would demonstrate an alternative way of looking at the gold to silver ratio, not in dollar terms, but in mining terms, as in what actually comes out the the ground. Sources to look for this data, could be the GFMS and the Silver Institute. Both organizations produce data which estimate global mine supply on a yearly basis. GFMS estimates that 3,168 tonnes of gold were mined globally in 2016, while the Silver Institute estimates that 25,112 tonnes of silver were mined globally in 2016. Assuming the data is accurate, the calculation gives us a number of roughly 7.9. This means that for every ounce of gold that came out of the ground in 2016, only 7.9 ounces of silver came out of the ground.

Let that sink in for a moment. Gold is 77 times more expensive than silver right now, ounce per ounce, but silver is not even 10 times more plentiful when it comes to mining output and the actual hard data. Said differently, with far less technology and less availability of data, the Coinage Act of 1792 established a gold to silver ratio of 15, which is a ratio much closer to what actually comes out of the mines, than the gold to silver ratio of 77 that we calculate today. When taking into consideration global mine supply, a more down to earth gold to silver ratio, pun intended, would be 10, and if following the strictest measure according to the hard data, the gold to silver ratio may be better suited at 8.

When an investor gains knowledge and understanding of the gold to silver ratio, indecision may be resolved depending on the output of the calculation. If it takes 77 ounces of silver to buy 1 ounce of gold, by all measures discussed in this article, this is an extreme level of undervaluation for silver. That is to say, silver is dirt cheap compared to both historical and mining ratios. In April of 2011, when the gold to silver ratio was approaching 30, silver was more fairly priced to “on-par” with where it should be priced in relation to gold.

An understanding of the ratios presents opportunities in investing. For example, if an investor thinks that 77 is too high of a ratio, then perhaps all the dollars that would be spent on precious metals be spent silver. Further, it could be wise to sell gold to buy silver with the proceeds. The opposite of this is true as well. When the ratio falls, such as it did throughout 2010 and ultimately bottoming in April of 2011, a smart investment decision could have been selling silver to buy gold.

We do not want to tell you what to purchase or what not to purchase. Certainly, there is truth to putting all of the eggs in the same basket, but for anybody who is on the fence, or new to the metals, an opportunity is presenting itself right now in the markets. Silver, by all measures, is very, very cheap, especially when compared to gold. Silver EaglesCanadian Silver Maple Leafs and Mexican Silver Libertads are nice examples of sovereign silver coins, and the SD Bullion Proclaim Liberty Bar, which comes individually sealed, is an excellent example of a privately minted silver bar. The good news is that we all have many choices we can make when it comes to our investment decisions, and since we hear the sirens and see the flashing lights, it may be prudent to see what is causing all that ruckus. It might just be the gold to silver ratio.
*Article written on 7/10/2017

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