By Jeff Nielson of Bullion Bulls Canada
NEW YORK (
) -- One question which I am asked regularly is how do investors decide how much of their precious metals dollars do they invest in gold bullion, and how much in silver? In other words, they are looking for a "ratio" to guide them. In fact, I will argue that there is an existing, visible ratio which provides investors with good guidance on allocating those investor dollars.
The gold/silver price ratio is a simple comparison of the price of silver vs. the
. With these two commodities having played a vital role in human commerce (and human culture) for thousands of years, the gold/silver price ratio is arguably our oldest "economic statistic". For most of the last 5,000 years it has averaged approximately 15:1 -- until this century, when a combination of developments skewed this ratio to its most extreme imbalance in 5,000 years.
There are many ways to demonstrate that the current price ratio -- of well over 60:1 -- is both unjustified and unsustainable. The starting point is to observe that the element of silver is roughly 17 times more plentiful in the earth's crust than the element of gold. Indeed, what is strange is that our much more primitive ancestors (who had no way of analyzing the composition of the earth's crust) did a much better job of pricing these metals appropriately than their modern descendants.
The result of well over half a century of grossly distorting the price of silver, both in absolute terms and versus the price of gold has clearly set up this market for a
-- at which time the market will "correct" the price imbalance, in the most brutal manner possible. The evidence of this upcoming event is all around us, much of it compiled by the years of painstaking research by
, the "dean" of silver commentators.
It is Mr. Butler who has chronicled the extreme-and-absurd
through the criminal activities of the bullion-banks in futures markets -- and mostly from New York's Comex exchange. As most of us know, identical activities have been taking place in the
, with GATA taking the lead in exposing that aspect of market-fraud.
However, what separates the two metals, and will ultimately lead to a major silver-default is that while gold is
, silver is
. While gold has industrial uses, it has filled such an important role in commerce (through being the best form of "money") and culture (crafted into jewelry and cultural artifacts) that virtually all the gold ever mined could (theoretically) be re-collected into a single stockpile.
, and its relative abundance (vs. gold) has resulted in silver being
in vast quantities; that is, it is used in the manufacture of goods where it is impossible or extremely impractical to recover/recycle this silver. This leads to a fundamental principle for all precious metals investors today: the price of silver is 100% certain to rise significantly -- both in absolute terms and vs. gold.
As I highlighted in
, fifty years of grossly under-pricing silver has literally destroyed global stockpiles and inventories. We know from inventory records that total global inventories have collapsed, in just the last 20 years. This has been supplemented by the research of Ted Butler, who estimates that global stockpiles (the total amount of silver which could come onto the market) have plunged by an equally precipitous amount.
As a simple matter of arithmetic and economics, the only way that the collapse of silver inventories can be stopped, and "equilibrium" restored to this market is through a dramatic increase in price. There is no other possibility, other than a total collapse of human commerce and industry.
Given these parameters, it is obvious that all precious metals investors should favor silver over gold, as of this moment. The question is: how heavily should investors tilt their portfolios toward silver? In some cases, "simple" does not equate to "simplistic," and I will argue that letting the gold/silver ratio guide your purchasing decisions is one such example.
My advice is to purchase your gold and silver in proportions dictated by the gold/silver price ratio. Thus, with the ratio currently about 62:1, investors buying gold and silver today would buy 62% silver and 38% gold. Inevitably, I will hear from gold-bugs who say "that's too much silver," and from silver-bulls who say "that's too little." Let me try to appease both camps.
For those saying that investors need more gold, I would point out that as soon as the price-ratio begins its journey back to some rational level (certainly well below 20:1) that investors will quickly revert to purchasing mostly gold with their paper money. Indeed, the moment that the ratio falls under 50:1, gold would become the majority purchase -- even though a 50:1 ratio is still totally unsustainable. In short using the price-ratio as a buying guide clearly defers to gold's status as the "primary" monetary metal.
At the other extreme, confident silver-bulls would argue that investors should be allocating even more than 62% of their precious metals dollars to silver. My reply in this case is to fall-back on the title to this piece: "investing for...novices." One must always be careful in offering any financial advice to novices, as you are essentially advocating that people make investment decisions at least partially based upon faith. Given that caveat, even being an ardent silver-bull myself, I would not feel comfortable in advocating that those new to this sector favor silver more aggressively.
For those investors who are already familiar with this sector, or once a novice does his homework and becomes acquainted with this market, I would certainly not argue against those who are capable of engaging in their own analysis -- and decide to increase their ratio of silver-buying.
Let me add that such ratio investing would not apply to decisions when it comes to buying gold and silver mining stocks. As many investors know, and as I have discussed previously, gold and silver miners (like all commodity-producers) provide natural leverage to the price of bullion -- with the degree of leverage for each miner being based upon their profit margin rather than simply the absolute price of bullion.
Thus, even with the extremely skewed price-ratio between gold and silver, there are gold miners that provide a high level of leverage to the price of gold, and gold miners that (due to low cash-costs) provide little leverage. The same situation is true with silver miners. Because of this, there is no simple formula that investors can use to make their investment decisions on the miners.
My personal assessment of miner valuations is that valuation of the silver miners vs. the gold miners is terrible. "Value investors" will argue this means pouring most of your mining dollars into silver miners. Investors who are more momentum-oriented will argue that we should favor gold miners at the moment as they are performing much better.
For many investors, there is one other large, looming question: how much of one's overall wealth/portfolio should be allocated to precious metals investments? It will sound like a cop-out to say that the answer is different for every investor. However, in this case I would argue that any simple advice would be dangerously simplistic.
How old are you? How wealthy are you? What is your future outlook on markets and the economy? What is your level of risk-aversion? Few investors will supply identical answers to all those questions (and other relevant factors), and thus few investors will have the same profile when it comes to precious metals investing.
If there is an easy answer to this question, it is "what percentage of precious metals investing will lead to the maximum peace of mind for each, individual investor?" Keep in mind that investing in precious metals is a form of insurance, much like insurance is a form of investing. Thus, having someone ask "how much precious metals do I need?" is a nearly identical question to asking "how much insurance do I need?"
This is a personal investment decision which is one of the few examples where buying and selling should be based more on how it makes you feel, rather than attempting to arrive at a decision purely through cold economic analysis. You keep buying until you have accumulated a large enough precious metals component that you don't worry about not having enough, and you stop buying the moment you begin to worry that you might have too much.
The only specific parameter which I will offer to investors is a negative one: the 10% precious metals component which is advocated by a large majority of mainstream financial advisers (or numbers very close to that) is clearly inadequate. It may have been a competent recommendation in previous eras, but not at a time when a collapse of the global (fiat-currency) monetary system is only a question of "when", not a question of "if" -- and where inflation is certain (at some point) to erode our wealth at an unprecedented rate.
Never in history has the need for economic insurance been this great. Protect yourselves accordingly.
Jeff Nielson studied economics for four years at the University of British Columbia, before going on to attain a law degree from that same institution in 1989. He came to the precious metals sector around the middle of last decade as an investor, but quickly decided this was where he wanted to focus his career. After publishing his own, amateur blog for a year, in 2008 he founded Bullion Bulls Canada: a web-site providing information and analysis to precious metals investors. Today, bullionbullscanada.com reaches a global audience of precious metals investors in more than 120 countries.