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We can’t compare gold and silver without first looking at the chart below
of above-ground stock of gold versus the visible gold market. Remember also
that almost all of this gold above ground is in the purest form and ready at
very low cost to come to market. This stock of gold is called reservation
demand. Reservation demand is a demand that is expressed by holding onto
something that you own. People who hold gold are demanding it by holding
it off the market. Gold, unlike many other commodities, is not consumed, and
therefore the traditional models and theories of supply and demand simply do
not apply. Of all the gold extracted from the relatively small number of
mines, only a tiny fraction is ever “consumed” in the true sense (about 9%),
with the overwhelming production added to the ever growing stockpiles of
governments, corporations and private investors, along with small amounts of
recycled scrap. For gold there is always a large stockpile and it never gets
any smaller, it is simply the owners of the stockpile who change.
 
This is not the case for silver as you can see in the next chart, and even
less for copper. You can see that silver also has a very high stock-to-flow,
compared to other metals, but very far from that of gold. Still these three
metals have a common monetary history that goes back a long way. How close is
the price of silver related to gold? In other words, how big is the
correlation between gold and silver? And should there be one?
Even though silver was taken out of the official monetary system about 150
years ago and gold about 45 years ago, they remained in the international
monetary system, if not in official form, at least as money in extremis and
in the shadow of the fiat system. While there is no more silver in official
international reserves, there is still a large quantity of gold left in
official international reserves and, since the 2008 financial crisis, this
amount has been increasing. The official sector still holds today in 2016
approximately 32,735 tonnes of gold but no more silver. However, gold and
silver are still monetary metals, even if not “officially”.
Prof. Antal Fekete says that, “in the case of monetary metals, in contrast
with all other commodities, high and increasing prices may not bring out new
supply. Rather, they might make supply shrink. Monetary metals are exempt
from the law of supply and demand.”
Before looking at the correlation between the price of gold and silver,
let’s look briefly at the supply and demand of both gold and silver. Looking
at the supply of gold and silver in 2015, we can see that gold scrap supply
is almost double that of silver but that mine supply is the largest supply
for both gold and silver.
Gold and silver demand shows a much bigger and significant difference. I used
different colors to highlight (red) the demand that is hard to recover and
recycled demand that is not wasted and can be brought to market at low cost
and quickly. As you can see in the charts below, industrial fabrication (hard
to recover) of silver is almost 6 times larger than that of gold. Industrial
demand for gold is 8.75% and for silver it is 50.3%.
In regards to the relationship between gold and silver, we observe great
variations in the silver/gold ratio. Even though there is 19 times more
silver than there is gold in the Earth’s crust, only 9 times more silver than
gold is extracted today. The historical 15:1 gold/silver price ratio is
closer to their abundance ratio of 19/1. One must not forget, however, that
the historical 15:1 ratio was almost always fixed or imposed by the State,
never by the markets. The price ratio is presently around 65:1. Observe in
the chart below the change in volatility of the ratio since the introduction
of paper and electronic currency. From 3200 BC to 1860 AD the gold/silver
ratio fluctuated between 2.5 and 17. That’s about 5000 years at an average of
10. It’s only after the introduction of paper money around 1900 that the
ratio started showing extremely wide volatility and moved far away from its
natural ratio of around 15, varying instead from 10 to 100.
Although we have seen in the last one hundred years very large variations
in the gold/silver ratio, the correlation between the two monetary metals has
remained very high, and that even after we moved from a bi-metallic (gold and
silver) monetary system to a mono-metallic (gold) one. In 1973, after the
collapse of the gold exchange monetary system, gold also left the official
monetary system, and we are now in a non-metallic monetary system. However,
as I mentioned above, gold remained in the system as money in extremis in
central bank reserves even after 1973. As you can see in the charts below,
gold and silver have maintained a very high correlation moving, close to 100%
during monetary crises like the ones in 1973 and 2008. Since 2012 it has been
around 90%.
It remains that silver is much more volatile than gold. Roy Jastram called
silver the “restless metal”. I think the much larger component of the
industrial demand, as compared to gold, makes silver more volatile. Silver
lost its official monetary role, but not its non-official one. In monetary
crises, even after being demonetised, its monetary aspect dominated the
industrial aspect, making it spike faster than gold. It became evident for me
during the 2008 global financial crisis and also when India restricted the
importation of gold. Silver’s monetary aspect is so deeply engrained in us
that it became the obvious alternative to gold when gold was restricted or
too expensive to acquire.
Others call silver the “poor man’s gold”. This pejorative name is not because
it is less valuable, but because it always played as an alternative and a
division to the more valued gold (around 15:1). For small transactions silver
was preferred, and copper for even smaller ones. Silver circulated more than
gold and copper more than silver.
Sandeep Jaitly, of Fekete Research, in an excellent article on
bi-metallism, The Validity of Bimetallism, argues that the problem of
bi-metallism comes with the attempt to fix prices. He further states, “The
problem was not with bi-metallism but with the mechanics of its
establishment. Bi-metallism is like Paradise so long as exchanges between the
metals are free, and mints are open to unlimited tender in both metals.” I
agree, and we have also seen since the end of the gold exchange monetary
system in 1973 that both gold and silver remained in the monetary system,
albeit unofficially and in the shadow, ready to shine again when the fiat
system would go into trouble and collapse.
I don’t think that silver, in this international monetary system collapse
and reset, will lead gold but, on the contrary, it will wait for gold to
signal the start of this new leg of the 2000 bull market that will bring gold
around $5,000 and silver around $200. So I will not be surprised to see the
gold/silver ratio reach 100 before decreasing to at least 40. As the price of
silver increases due to the monetary demand, some of its industrial demand
will drop; but I think the monetary demand will more than compensate the drop
in industrial demand.
Do not dismiss history with such ridiculous statements as “relic of the
past” or “useless metal”. Every scientific invention or innovation has as its
inspiration observations and knowledge of the past. There is a good reason
why gold and silver have survived as monetary metals while every fiat
currency has passed away after a short passage. All fiat systems, even those
that use mathematics, are easily abused by sovereigns. It’s not so easy to
create gold and silver to infinity. What Aristotle said 2,500 years ago is
still valid today: “In effect, there is nothing inherently wrong with fiat
money, provided we get perfect authority and god-like intelligence for
kings.“
“Gold and silver have been ordained not by corrupt governments and their
hand-picked henchmen, but by millennia of human experience under divine
guidance. They are the true monetary metals that have been handed down to us
from Biblical times.” Antal Fekete
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