Welcome to Finance and Fury

Today – Talk about a Money Illusion and the GSR 

  1. Gold has been on a rally – but silver hasn’t gone up by as much

The Gold-to-Silver Ratio: What is It and Why Does It Matter?

  1. For experienced investors, the gold-to-silver ratio is one of many indicators used to determine the right (and wrong) time to buy or sell their precious metals.
  2. The gold/silver ratio is simply the amount of silver it takes to purchase one ounce of gold. If the ratio is 25 to 1, that means, at the current price, you could use 25 ounces of silver to buy one ounce of gold. 25 to 1 would be considered a narrow ratio
  3. Other factors – including economic uncertainty, inflation frenzy and debt – have encouraged millions to invest in gold and silver, and in the past few years, small-scale investors have begun to climb aboard.
  4. Yet despite these market developments, to many, the gold-to-silver ratio remains a vague, elusive mystery.
  5. Currently – GSR ratio is around 96.5 times – $26 for Silver and $2,718 for Gold
    1. Buy 96 ounces of silver for one ounce of gold
  6. What can this number tell us?
    1. Investors who trade gold bullion, silver bullion and other precious metals scrutinize the gold-to-silver ratio as a signal for the right time to buy or sell a particular metal.
    2. When the ratio is high, the general consensus is that silver is favoured. This is because, relative to the ratio, silver is somewhat cheap.
    3. Conversely, a low ratio tends to favour gold and may be a signal it’s a good time to buy the yellow metal. Many large-scale, experienced investors may trade their silver for gold as the ratio drops.
    4. Unfortunately, because the gold-to-silver ratio fluctuates so wildly, it can be difficult for novice or small-scale investors to read the signals and make a profit.

Historically, what did the Gold-to-Silver Ratio look like?

  1. Since 1687 – as far back as the records reach – the gold-to-silver ratio vacillated between roughly 14 and 100.
  2. Prior to 1900, the gold-to-silver ratio hovered around 16. This was likely because many countries were using gold- and silver-backed currencies. For instance, France and the United States (among others) assigned statutory limits on what the ratio could be.
  3. 1900 – Throughout the twentieth century though, the gold-to-silver ratio has averaged about 47-50 and has fluctuated wildly at times
  4. Fundamental reasons – U.S. Geological Survey estimates that there’s 17.5 times more silver in the Earth’s crust than gold, which could provide another explanation for the pre-1900 gold-to-silver ratio average.

Take a look at some of its implications

  1. The most important implication is that there is no characteristic value for the gold-silver ratio (GSR)
  2. That means that there is no “true north”, or no mythic value (16, for instance) to which it is attracted, and to which it would return if only the world stopped manipulating its price
  3. Economists have some conclusions around why the ratio changes over time – has to do with inflation and interest
    1. The gold-silver rises during deflationary periods and disinflationary periods
    2. The gold-silver ratio falls during inflationary periods
  4. What is unclear is whether a rising GSR causes deflation, or deflation causes a rising GSR – either way – a strong correlation
  5. To dig deeper – have a look at some measures that can be used for deflation/inflation

First – look at the USD Index versus Gold prices

Important as gold and silver are valued in dollars –

  1. Intervals when both the USD index and the gold price rise are considered deflationary
    1. Deflationary – deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but sudden deflation increases it
  2. If gold rises and the US dollar index falls – we have inflation
    1. Inflation is price rises – not the same as CPI – CPI is used to measure prices but leaves out the rise in hard assets – and other essentials in cost of living, like level of debts being taken out

The cycle of money – has four stages – Inflation, Disinflation, deflation, and reflation

– Very similar cycle to the K wave theory

  1. In stage one, the groundwork for inflation is laid by central banks but is not yet apparent to most investors. This is the “feel good” stage where people are counting their nominal gains but don’t see through the illusion – that inflation is the cause for a lot of the price gains – summer period
  2. Stage two is when inflation becomes more obvious. Investors still value their nominal gains and assume inflation is temporary and the central banks “have it under control.” – This is where a weakness in purchasing power starts to increase
  3. Stage three is when inflation begins to run away and central banks lose control. Now the illusion wears off. Savings and other fixed-income assets like bonds rapidly lose their real value.
    1. If you own hard assets prior to stage three, you’ll be spared. But if you don’t, it will be too late because the prices of hard assets will gap up before the money illusion wears off.
  4. Finally, stage four can take one of two paths.
    1. The first path is hyperinflation, such as Weimar Germany or Zimbabwe. In that case, all paper money and cash flows are destroyed and a new currency arises from the ashes of the old.
    2. The alternative is shock therapy of the kind Paul Volcker imposed in 1980. In that case, interest rates are hiked as high as 20% to kill inflation, but nearly kill the economy in the process.
  5. This last phase should have technically occurred if inflation was visible in the CPI measurements –
    1. There is so much money created from debt – but put into hard assets and not being spent In the economy – so it isnt visible

Going back to look more closely at the GSR

Time periods – Looking more recently

  1. 2008 – we were experiencing disinflation – as the GSR rose from 55.7 to 77.1
  2. 2009 was characterized by inflation, and the GSR fell from 77.1 to 63.3.
  3. 2010, we had disinflation, and the GSR rose slightly Bottom of Form
  4. Then there was a big inflationary pulse into late 2011 saw the GSR falling to 40.8
  5. The following disinflationary episode that lasted through 2013 saw the GSR rise to 65.9
  6. Since then, the dominant trend has been deflationary, although realistically there have only been two deflationary pulses–through early 2015 (GSR 74.5) and over the past 18 months (GSR at 88.6). Most of the time has been consumed by short inflation-disinflation cycles, with slight rises and falls of the GSR without significant trend.
  7. Over the last 12 years – bigger picture is deflation – some cycles of inflation and disinflation
    1. deflation is a decrease in the general price level of goods and services – Characteristics are accompanied by real debt levels rising, pressure for lower wages, declining business profits,
    2. Relates to the K wave theory – does line up – Autumn get disinflation and winter get deflation
    3. Especially over the last 12 months – seeing gold go up quite a bit whilst silver has risen, but not by as much
  8. So long as deflationary conditions persist, the GSR may rise without limit. As long as debts are created beyond any ability to repay them, deflationary conditions will rule. 
    1. Under such conditions, despite the GSR being pretty much the highest in history, gold remains a better investment than silver.
    2. However, as much of the actual deflationary effect is brought about by cycles of inflation and disinflation, there are  brief intervals where silver makes a better investment than gold.But rather than using the level of the GSR as your selection criterion, you need to look closely at monetary policy instead.

What does this mean for the future?

  1. Some experts predict the gold-to-silver ratio will return to its long-term, pre-1900 average of 16 to 1. Many factors are cited in this favourable claim
    1. It’s worth noting however, among these experts are some of the most ardent advocates for silver investing.
    2. in order for the ratio to return to its pre-1900 average, the price of silver would need to rise to approximately $105 per ounce in USD –
  2. From Here – and where we are at in the cycle – likely that gold continues to rise at a greater rate than silver –
    1. gold-silver rises during deflationary periods and disinflationary periods – could be a large reason why it is rising at the moment and has hit 96
    2. However – if we suddenly get high levels of inflation creep into the economy over the next few years – through proposals of helicopter money – then silver would be a decent hedge against the loss of real value of assets from inflation

Summary

The gold-to-silver ratio is indeed one of several valuable tools used to determine the optimum time to buy gold or silver bullion.

    1. Just remember that it is wise to avoid using these as the sole tool when making investment decisions – Only the most experienced investors make profits using a short-term view, and even they suffer errors in judgment.
    2. With a long-term view, you may choose to buy silver when the ratio is high – buying higher quantities with fewer dollars
    3. Typically, the gold-to-silver ratio serves as an impetus for diversifying holdings – If one investment flops, alternate investments in your portfolio pick up the slack – or losses
    4. Precious metals baskets and the like can help to diversify and hedge against inflationary periods

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

 

 

 

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