However, central banks still hold large amounts
of gold as a store of value. The U.S. central bank, for example, holds 78.2% of
its reserves in gold.
So gold is still being treated as money... at least by central banks.
Silver, on the other hand, is not.
Just look at the ratio between the prices of gold and silver, which
Porter has covered before. When both metals are being used as currency, the
ratio of their prices is about 16. Meaning gold is 16 times as expensive as
silver. This was true for hundreds of years leading up to 1900, after which many
countries abandoned their silver pegs.
Because central banks and citizens abandoned their silver, since 1900,
the price of gold has been, on average, 52 times the price of silver. All the
silver being produced was funneled into jewelry and industrial uses. And it more
than met silver demand. Prices fell.
So why did silver outperform gold in the late 1970s?
With the rise of inflation, investors lost faith in the U.S. dollar. They
then turned to gold and silver as alternative ways to hold money. Once again,
silver became a currency... And the ratio between gold and silver (which had
soared above 32) returned to around 16.
The following chart shows the ratio of gold to silver going all the way
back to 1832.
As you can see, silver appreciates versus gold every time the U.S. goes
through a monetary crisis. When gold and silver are both considered currencies,
the ratio of their prices returns to around 16.
But why 16? If demand for gold and silver were identical, and we mined
silver at 16 times the rate we mined gold, then a ratio of 16 would make sense.
But gold isn't 16 times as scarce as silver. According to the U.S.
geological survey, we only mined 8.2 times as much silver as gold last year.
This makes the high premium that gold demands even more unusual...
So it must be demand. Demand is currently higher for gold because it is
already considered a store of wealth. Central banks use large quantities of gold
to back their reserves. Demand
for gold shouldn't change much. But the demand for silver will increase as
investors begin to use it as another way to diversify out of the dollar. This is
what will bring down the ratio.
And demand for silver is already on its way up. The ratio has already
fallen from 81.4, its peak reached in 2003. Inflation is climbing, just like it
did in 1973... And silver is starting to become a legitimate alternative to
holding U.S. dollars.
