February 7, 2012

Gold-Silver Ratio

For more than a month now I've been able to succeed in not mentioning the S-word. But, al things come to an end. I'm talking about the gold-silver ratio.
Obviously there's still a great misconception relating to this ratio, so here's my challenge to make it as clear as possible.
To achieve my goal I'm not going to throw facts at you why gold is any different than silver. This hell of a job already has been done by FOFOA in this post. It couldn't be explained any better, so please read it if you haven't already done it before.
My purpose is to show that any comparison between these two precious metals is as logical as an eleven-city race in June.

In order to get a good result I would like to create an other comparison (or ratio if you like). Although I know it might seem strange on the first sight, I hope I can proof it isn't so strange at all.
So here is my own ratio.....the paint-pencils ratio.
This ratio simply shows us the amount of paint in the world related to the amount of pencils. Personally I think it's fair to put a ratio on this as they both are used by artists in various ways. It can show us whether the paint is expensive, or the pencils are compared to each other.

As we have our new ratio here, it's time to start with the test. At first sight there's nothing wrong with our new ratio. We simply compare two "commodities" by their physical availability. When there is a price setting in the markets for both "commodities", we simply look to the availability worldwide and than we can conclude whether one is overpriced or not. This is how it works with the gold-silver ratio also.....no difference here, agree?

What happens when the function of either one of these "commodities" changes? By change I mean when a particular commodity's function changes. For example when a painter makes a painting? It's still the same paint, priced by the markets.
But as people value art different than the physical paint, there is a total different price setting.
How is that possible? It is still the same paint, isn't it?
That's because art in some kind of a way is a store of value. Not the most liquid one, but it is one. So try to imagine what has happened with the price of the particular paint used by Leonardo da Vinci for the Mona Lisa. The market price was very low, but the value of the painting is enormous. Why? Because we, the people, value it as something valuable. (Does this sound familiar to you).
The value of this paint changed because it's first function as a commodity changed in something else.
Do you still feel comfortable to put a ratio on paint and pencils if you knew this paint was going to be used for the Mona Lisa of the future? Or following this, just buy pencils when they're undervalued by some price mechanism, knowing there is a very, very good chance paints' function would change?

This is in my opinion the problem with the gold-silver ratio.
Yes, it both are precious metals; and yes they're both commodities today. In fact not exactly but hey, you can get that one from me.
What I'm trying to make clear is that the function of gold is different because it's a store of value. The only store of value as a focal point in our new monetary system. Our Central Banks already adapted to the new situation and now almost all banks own only gold. Does this mean silver won't outperform gold in this current situation? No, definitely not. In fact it is very well possible that this will happen. But this speculative out-performance is occurring under the current commodity comparison.
Nowadays gold is indeed priced as a commodity, but this won't last forever. It will be valued in a way maybe not to contain by everyone. How it's priced by it's availability today is far, far from telling us anything about future value...


Robert LeRoy Parker said...

I think many of the silverites these days are the modern day reincarnation of Schumpeter's monetary monomaniacs. They espouse the virtues of silver as hard money but really just desire silver inflation. The merits of bimetallism are never discussed anywhere in the PM blogosphere as far as I know. How silver fits into the next system in their minds is something of a mystery as well.

Boefke said...

To understand the impact of the things occurring before our eyes it's requiring an out of the box attitude.
This is what's missing with most silverites. Looking from an angle inside that known box. Than it's almost impossible to grasp the clue discussed in the "freegold"-world. It's the mere materialistic view, over the philosophical one......my thought. Time will tell,

Piripi said...

There are no merits to bimetallism. It is an anachronism stemming from a period where some countries were on a silver standard and some on gold.

Bimetallism would only be advantageous if a greater quantity of metal was systemically required than either gold or silver alone could supply.... but we know this is not the case, as the market only requires the value of the metal to be elastic, not the physical supply. The quantity is only relevant to a fixed standard, not a floating one.