My Silver Bonafides

Now that everyone and their mother and their mother’s manicurist is talking about silver, I thought today would be a good time to trot out my own Silver Bonafides.  Long-time readers know that I introduced the concept of the Silver Slingshot Effect into the financial blogosphere a year and a half ago.

In my May 2009 post “Rise of the Silver Surfer“, I explained the sling shot effect thusly:

Let’s talk valuation.  An ounce of gold had historically traded at a ratio of around 15 to 1 versus an ounce of silver for many decades.  This was not a man-made ratio; there is, in fact, roughly 15 times the amount of silver as there is gold in the earth’s crust, so this ratio was more of a geological truism.  Gresham’s Law, however, brought this ratio into focus; Named for a Tudor-era English financier, the law held that as either gold or silver got ahead of itself in price, you could just buy the other one as a form of arbitrage, so this 15 to 1 thing was fairly solid.  That all changed between the 1960’s and 1980, a period of time during which silver was largely de-monetized.

The yellow metal is trading at around $950 an ounce as of this post and silver’s at slightly above $14.  The gap right now between gold and silver shouldn’t be anywhere close to that historical 15 to 1 spread, but should it really be at 70 to 1?  The smart money may be looking for a reversion to the mean with the gap this wide.  There could be a ton of ground for silver to cover while narrowing that gap, and that brings me to the exciting part…The Slingshot Effect!

At current gold prices on the spot market of around $950 an ounce, a more traditional ratio of 50 to 1 would look more like $20 plus for an ounce of silver, a gain of 40% in the commodity itself.  Now, picture the price of gold finally cracking above the $1000/ oz mark that it’s been flirting with for a year…and staying up there!  The torrent of buying that could come in would probably be ferocious enough to wrench the price of silver higher at a much faster rate than gold, as silver is a much smaller market.

It’s been posited that the silver market is so tight and unaccustomed to speculators (compared to the gold market), that if someone calls for physical delivery of the metal (which a contract enables them to do) the entire mechanism could break down, triggering an explosion in prices due to the physical scarcity.

Picture the stored potential energy of one end of a rubber band being held back (representing silver prices) as the other end of the rubber band is being pulled forward (gold prices).  The further you stretch the “gold” end of that rubber band, the more the potential snap you’re going to get when you finally release the silver end.  That’s what we could be looking at with a 70 to 1 gold to silver ratio and a tight market with few ways to get exposure.  That’s the Slingshot Effect.

Gold is within spitting distance of it’s 2008 peak price as well as it’s all-time high price.  Silver, on the other hand, has been cut in half from it’s 2008 high.  As far as the all-time high for silver?  We’re talking $50 back in 1980, not adjusted for inflation.

In that same post, I also mentioned my favorite silver play, Silver Wheaton ($SLW), which I called “the miner without a mine”.  The stock was around 8 or 10 back then, now in the mid-30’s.

One other item I’ll point you to is Barry’s hysterical post this morning about how Quantitative Mining is “debasing the gold currency”.  Gold priced in Silver looks like the US Dollar these days.  Love it.

Sources:

Rise of the Silver Surfer (TRB)

Quantitative Mining Debasing Gold (TBP)