Silver or Gold: The Great Debate
From 2006.
Part 1
This problem faces every contrarian investor who has decided that the U.S. dollar will not reverse from the course it has been on since 1913: a 95% reduction in purchasing power.
There are a few contrarians who think that deflation is coming: both monetary deflation and price deflation. As far as I know, there are only about a dozen of them who write newsletters or run websites. For some reason, most of the deflationists seem to think that gold’s price will rise in a mass deflation. They do not warn their subscribers, “Don’t buy gold or silver!” If they did, they would have fewer subscribers.
Robert Prechter has never joined this camp. He started predicting $125 gold at least 15 years ago. He is consistent. The other deflationists are either inconsistent or silent on the gold question.
In contrast, I think gold’s price will rise because the money supply will rise. I recommend that your first $10,000 in gold be purchased as one-ounce coins. American eagles are more expensive than Krugerrands. Eagles by law are designated as numismatic coins. In 1933, when the U.S. government confiscated gold coins and bullion, it exempted numismatic coins. If you are worried about gold confiscation — I am not — then the eagles make some sense. But you get more gold for your buck with Krugerrands. On these and other precious money issues, click here.
Why gold’s price should rise in the face of falling prices, including all other commodity prices, remains a mystery to the rest of us gold bugs.
The original deflationist, J. Irving Weiss, announced a looming price deflation in 1967, at Harry Schultz’s original gold conference. I was there. He told us to buy T-bills. I bought gold coins instead. Since then, American prices have risen by about six to one. He remains the model deflationist: he never retracted his prediction over the next three decades. His son Martin continues to announce it. But the father had an excuse for his blindness. He had borrowed $500 from his mother in 1929 and turned it into $100,000 by 1931.
He had made his fortune in the classic bear market of all time, and he never figured out that this was a once-in-a-career opportunity. The Great Depression dipped his investment strategy in cement.
Here, I am talking about hard-core inflationists. Most of them favor gold over silver. A few prefer silver over gold for their core holdings. I am not one of them. Let me tell you why.
THE DE-MONETIZATION OF SILVER
In June 1963, the government passed legislation severing the legal connection between silver certificates and silver. No longer could you take in a silver certificate to the U.S. Treasury and get a fixed number of ounces of silver.
I could see exactly what was coming. Gresham’s Law was about to be re-confirmed: “Bad money drives good money out of circulation.” That is, the government-overvalued money drives out of circulation the government-undervalued money. I began buying silver coins the next month with my first full-time paycheck. I made $500 a month, and by September, I had bought over $1,000 in silver coins. I believed in thrift!
I bought them because the local bank had silver coins. I kept buying more every paycheck. I remember a teller — a young woman — who told me: “You can always get coins. Why do you want to buy so many of them?” I don’t recall what I told her. I doubt that I explained Federal Reserve policy and Gresham’s Law to her. Technically, the bank had to provide coins for me on request. They had only silver coins, other than pennies and nickels. I knew what would come soon: clad coins. They did.
By October, silver coins were going out of circulation. There was a shortage on the turnpikes for making change. There were no clad coins yet. They came in 1964. So, dimes, quarters, and fifty-cent pieces were in short supply.
That was the de-monetization of silver. Collectors removed them from circulation. Occasionally, we would find a silver coin among the legally authorized slugs, but not often after 1966.
The public did not know the difference. There was no outcry against the government for having legislated this gigantic counterfeiting operation. Copper coins with shiny laminate on them were just fine with the average Joe.
Beginning around 1968, gold began to be demanded in ever-greater quantities by foreign governments, especially France. This had been going on steadily for a decade. The Johnson Administration attempted several counter-measures, such as a two-tier gold price: one for the European free market in gold and the other for central banks to buy American gold. Nothing worked. Finally, Nixon unilaterally ended gold convertibility in 1971, which destroyed the 1944 Bretton Woods agreement: central banks’ use of the dollar as their reserve currency, with the dollar redeemable in gold at $35/oz, but only by national governments and central banks.
The central banks still kept their interest-bearing T-bills and other dollar-denominated assets as part of their legal reserves. They kept gold, too, but from 1971 on, they still bought mainly dollar-denominated assets, not gold. This is true today. The dollar has never lost its reserve currency status, despite the closing of the gold window. The bankers ignored this semi-final de-monetization of gold in 1971, in much the same way that Americans ignored the final de-monetization of silver in 1963.
I say semi-final. Why not final? Because the U.S. government did not immediately sell off its gold hoard in 1971. Most central banks have refused to sell all of their gold. They have generally ceased buying newly mined gold or gold from the free market, but they do buy gold bullion from each other. Some of them have sold off part of their gold supplies, but this has been done mainly since the mid-1980's.
Silver, in contrast, has been completely de-monetized. It is an industrial metal or a jewelry metal. Its price peaked in January 1980, at $50 an ounce. It then fell for the next 23 years, bottoming at $4.67 in January 2003. That was a 90% loss of price, but really closer to 94%, because of the fall in the dollar’s value, 1980-2003. In short, silver was an investment catastrophe for over 20 years.
Gold is perceived as a money metal that is used by central banks. It is used by Asians as an inflation hedge. Silver has lost that perceived value. So, silver is more volatile. There was nothing to prevent its fall after 1980.
There is something else to consider. For almost the entire 23 years of its price decline, there were bullish silver brokers who kept talking about the huge gap between low silver production and high silver consumption. Here is my question: If that argument led to losses for 23 years, why should anyone believe the same argument today? There was a negative correlation for most of those 23 years between that argument and the price of silver.
The official figures for demand and supply remain steady, year after year: from 770 million ounces to 900 million ounces. See the figures for 1995-2004.
I have seen no plausible explanation for the fact that for 23 years, a metal that was being consumed out of unknown storehouses could keep falling in price. If the publicly available supply/demand statistics were that impossible for that long a period — silver supplies by the hundreds of millions of ounces per year coming from above-ground sources (where?) — then why should anyone trust price forecasts based on today’s supply/demand statistics?
Until a silver bull can explain clearly from verifiable evidence the origin of the silver held in above-ground sources — at least 200 million ounces per year every year for 25 years — I will pay no attention to the argument. How was it that above-ground supplies did not decline in availability, despite a 94% decline in silver’s real price? When you hear this argument, be polite, but ignore it. Do not invest a clad dime based on this argument.
THE GOLD-LEASING OPERATION
For at least a decade, central banks have been lending gold to specialized brokerage firms, called bullion banks. The bullion banks borrow this gold at absurdly low interest rates — well under 1% per year. Then they sell this borrowed gold into the world’s private gold markets. This keeps down the price of gold: added supply.
The bullion banks then take the money they earn from the sale of this borrowed gold and purchase higher yielding debt certificates. They may get 6%. So, they are borrowed short — the low lease rate — and lent long: bonds.
They owe gold, not money. The central banks still list this leased/sold gold on their books. But there is no leased gold in central banks’ vaults; it has been leased out, then sold. The public believes that this gold is there, but it’s gone. It has gone into jewelry, maybe in India. Some daughter has her share of the central banks’ gold in her dowry in the form of a necklace or rings.
The central banks do not report that it is gone. So, there is always the threat that the public will figure out that the leased gold is gone. But, for now, the politicians either are as ignorant as the public or content with the arrangement. So, the odds are that the public will not learn about the missing gold. In any case, voters are just about incapable of mounting a political attack on central banks, which truly are untouchable politically.
But the fact remains that the banks have depleted their hoards of gold. So, their ability to push down the price of the gold is becoming more limited. Central banks have not announced lately the usual warning: “We are going to sell gold over the next few months.” Of course, no profit-seeking owner of a commodity ever announces his plan to sell. That would depress the price. He wants to maximize the sale price. In contrast, central bankers do make these announcements. This indicates that their profits come from other sources. One such profit source is political: the public’s perception that monetary policy is sound, a fact testified to by the fact that gold’s price has not risen much. The central bankers are temporarily buying the illusion of price stability: a lower gold price.
This perception is now changing as gold’s price keeps rising. Yet the kitty is depleted. The gold has been leased, then sold. There may be some future announcements of some central bank’s looming gold sales, but the silence so far has been deafening.
So, the gold overhang of the central banks is no longer the sword of Damocles. It is more like the switchblade knife of Damocles.
The central banks now face a major problem. If gold’s price gets too high, the private bullion banks will be trapped. They owe gold to central banks, but they cannot afford to buy gold in the private markets in order to repay it to the central banks. If they are ever asked to repay, they will go bankrupt.
The central banks therefore will face exposure as being in collusion with a bunch of profit-seeking Enrons: busted and owing the government’s gold to the central banks. My guess is that central bankers knew from the beginning that they would never see this gold again. They just wanted a cover: “leasing” rather than “sales” of the government’s gold.
The downward pressure on gold is today no longer so great as it was a decade ago. The threat is reduced because the vaults are less full.
No central bank holds silver as a monetary reserve. No central bank is committed to buying or selling silver for public perception reasons. Silver has been de-monetized. It is no longer on the political radar. So, silver is closer to a true free market commodity. It is therefore more subject to the ups and downs of the business cycle.
You can make more money in silver when the market rises: no overhang of leased silver in central bank vaults. You can also lose more money when silver falls, along with the economy: no central bank buying of silver.
Finally, if the bullion banks are ever asked to repay the gold, the gold bullion market faces a day of reckoning: massive buying by shorts (bullion banks) or else the widespread awareness that central banks do not have as much gold to sell off to keep down its price. Both events would drive up the price of gold. There is no comparable upward pressure for silver.
THE GOLD/SILVER RATIO
There was a close correlation for many decades: 15 to one. That was because this ratio was set by Federal law. It was a price control. Gresham’s law always took over. The overvalued metal would drive out of circulation the undervalued metal. For as long as the government would supply the undervalued metal, the coins would circulate side by side. But when the gold/silver ratio diverged too much from 15-to-one, speculators would buy up the coins of the undervalued metal and ship them abroad or melt them down for their value as metal (higher) rather than money (lower).
To find today’s ratio, divide the price of gold by the price of silver. It is nowhere close to 15 to one. In 1963, when silver went out of circulation, silver was about $1.30, while gold was $35. That was 27 to one. Before 1963, silver’s price was lower, so the ratio was higher. But the ratio did not matter. Gold’s price was a fake price. Americans were not legally allowed to own gold bullion. So, silver circulated. Gold didn’t. Then, in 1963, it became profitable to buy silver coins and hoard them or melt them down. Silver coins disappeared.
Again, the gold/silver ratio as a forecasting tool produced only losses, 1980 to 2003. Silver’s market price fell by 90%. Gold’s price fell by 70%. The gold/silver ratio increased.
When you discover an alleged semi-fixed price ratio that produces forecasting errors for 23 years, it is best to avoid adopting it as your precious metals allocation strategy.
In any given 12-month period — and you can’t be sure which 12 months — the price of gold or silver may rise or fall by a greater percentage than the other. It does no good to trade back and forth, given the income tax consequences. You may do it once, but let it go at that.
STORAGE PROBLEMS
The best way to buy silver is to buy 90% silver coins: pre-1964. Take delivery. The sack of coins weighs over 56 pounds. Get them divided into two bags. I recommend dimes: more transactions per bag. But it doesn’t matter that much unless there is a complete monetary breakdown.
Gold coins are far more versatile. That is because they are worth more per unit of weight and volume. They are easier to hide. They are easier to move across a border.
Originally published on February 8, 2006.
Part 2
I published my report on “Buy Silver or Gold?” on February 7. By the end of the week, long-time silver bull Franklin Sanders responded. On February 8, I published Sanders’ article and my paragraph-by-paragraph response.
Unless you are invested in gold and/or silver, the details of this debate may not interest you enough to read a long debate. But you should at least know about its existence. It is a debate over this question:
Will above-ground supplies of silver run low before above-ground supplies of gold — gold actually available to the market — run low?
I answer in the negative. Sanders answers in the positive.
It is also a debate over this question:
In a time of an unexpected level of price inflation or after a terrorist attack, is the demand for silver likely to exceed the demand for gold?
I answer in the negative. Sanders answers in the positive.
Finally, it is a debate over this question:
During a recession, is silver’s price likely to fall by a greater percentage than gold’s price?
I answer in the positive. Sanders answers in the negative.
I think a recession is coming next year, and maybe late this year. This is not written in dry cement yet. Wet cement, yes.
HI, YO, SILVER!
Those of us who are old enough to remember Fred Foy’s introduction to every Lone Ranger episode remember that famous phrase. Yet in the history of silver, this phrase has applied only once: 1979. That momentous, incomparable opportunity to make potfuls of money ended with the worst bloodletting in modern commodity history. To understand what happened, take a look at the chart of silver’s prices, from 1792 to the present. Go to this page.
Then go to “Yearly Silver Charts.” Click the box for “1792-present” and then “View Charts.”
From 1792 to 1972, silver went essentially nowhere: 180 years of no profits for silver investors. Then silver began moving up. I began selling silver as an agent of a broker (Monex) in 1973. I did this for less than a year. Then I went into writing full-time.
In 1979, silver spiked upward by 10 to one. It hit $50/oz in January 1980. There had never been anything like this before in silver’s history. Then, beginning in mid-January 1980, it fell like a stone. It kept falling until 1991, when it bottomed at $3.60.
Search long and hard; you will not find anything to match the spike in silver’s chart.
What happened? Bunker Hunt happened. The multibillionaire oil man started buying silver futures contracts in 1973. He kept accumulating contracts, pyramiding them: using profits in his position to buy more contracts. He then started demanding delivery in 1979, when the price of silver was $5.
Demanding delivery of actual commodities is rarely done in the commodity futures market. Those who have gone long (buyers of future commodities) buy an offsetting short position and take delivery of their money. There are vastly more futures contracts promising to deliver any commodity than there are supplies of this commodity. Some of those speculators who were short silver saw a crisis looming: no silver to deliver. They sold their positions. They did this by buying “long” positions, which drove up the price. It was domino time for silver shorts all through 1979.
Hunt was trying to corner the market on silver. As a multibillionaire, he was feared. He might be able to do it, investors thought. They were wrong.
Two things happened to stop him. First, the FED reversed policy in October 1979, from monetary inflation to monetary stability: tight money. Interest rates began to skyrocket. The end of double-digit price inflation was imminent. Second, the commodity exchange changed the rules. No one was allowed to buy “long” contracts except to cover existing “short” contracts. Demand for silver futures contracts died overnight.
This caused the peak price in January. Then down went silver. Hunt could not cover his pyramided long positions. The commodity exchange sued to collect. The FED intervened and provided a billion-dollar loan to Hunt to give him time to liquidate his oil holdings and meet his silver contracts’ obligations. He had to collateralize this loan with his oil holdings. Hunt and his brother soon went bankrupt. He had to liquidate everything except his home, which was protected by the Texas homestead law. All that remained was his famous quip regarding the billion-dollar loan: “A billion dollars just doesn’t go as far as it used to.”
Newcomers to the silver market may not remember what has gone before. Silver is approaching $10 now, up from $3.60 in 1991. That is a nice move upward. It began before gold’s move in April 2001. The two metals have moved up in tandem since then.
The question is: Will this continue?
I think it will, but not in lock-step. If we get a recession, the upward move could easily reverse. With the inverted yield curve almost here, a recession looks likely for 2007. Only the FED can lower this risk by inflating, which it is now doing.
ALL THAT SILVER IS ALMOST GONE!
There is a story that the U.S. government at one time owned 1.5 billion ounces of silver. It no longer does, or so the story goes. It is not clear exactly when it was sold, or how, or to whom. You get different stories from different silver bulls.
There should be only one story: The government sold it into the market at particular times at particular prices in specific quantities. There must be public records. If there are, then we know when it was sold. If there aren’t, then all we have is a really good sales brochure story.
The standard account is provided by the Silver Users Association. In 1970, the government authorized the sale of its remaining silver hoard, which was converted into commemorative coins. By the early 1980's, the government had sold off all but 139 million ounces of its silver. This was finally sold by 2000. By the end of 2000, silver’s price was down to a little over $4.50. The following December, it bottomed at $4.10. It began its upward move, one month after the retroactive official end of the 2001 recession. It ended 2002 at $4.75. Silver users could buy all they wanted from above-ground supplies, just as they had been able to do since 1980.
It is always the same story among silver bulls: “Next year, silver will be in short supply.” I ask: Why was this story wrong for over two decades?
When Hunt began buying, the price of silver responded rapidly. By late 1979, people were selling their silverware to silver users, who were melting down these spoons and forks. If there was any silver in the world to sell, people were selling it to commercial silver users.
This is why the familiar story of the hundreds of supposed hundreds of millions of ounces of silver serving as an overhang, 1968-2001, is not credible, apart from specific evidence that it was being sold into the market by the government, in dribbles and drabbles, all the way up and all the way down.
If a specific quantity of any commodity is available for sale, then it is in people’s inventories. It is therefore in the market. It can have no future effect on price until it gets sold off and used up to make things that leave behind no scrap.
It costs money to hold silver in inventory. You lose any interest on the money you did not invest. You pay for storage and insurance. Why would anyone in his right mind have held silver in inventory after 1980? Only for short-term reasons. If speculators held 1.5 million ounces of silver inventory throughout the 1980s, they were dumber than Congress.
My point is simple: Only economic ignorance or the fear of an imminent cataclysm kept silver bullion hoarders from selling their silver to silver users, 1980—2003. If we are now facing an imminent depletion of above-ground silver supplies, then the reason has to be that the poor dumb clucks who held silver bullion are at last dying off, and their heirs are selling silver to users. But this has been going on for years. What is new?
When any commodity is sold to final users, the inventory shifts from speculators to the final users. If silver is used in jewelry, it is still in buyers’ personal inventories. If it is used for most industrial products, it is still available as scrap. Only as the old products are junked and buried in landfill does silver cease to be in someone’s available inventory. It may not be in bar form. It may have to be melted down and poured into bars. But it is still in someone’s inventory.
We saw this form-transformation process in action in 1979. Silver came out of personal inventories all over the world. Bunker Hunt had no possibility of ever cornering the silver market, even if the exchange’s rules had not been changed. Either at $60 or $80 or $100, he would have faced the reality of the silver market: Demand calls forth newly available supplies, which keeps prices from rising. When that day arrives, those who are “long” are trapped.
We are told that the COMEX used to have 1.5 million ounces in reserve. If true, this means that silver was in an easily accessed form: labeled bars. But the fact that these bars have been bought by silver users and converted into new forms of silver is not proof of a major decline in the quantity of above-ground silver. It only means that silver will be more expensive to purchase. It means that converting scrap silver to bars of silver will have to be paid for.
This will mean a rising price for silver if demand continues to rise, but not necessarily a spectacular increase. It is not that purchased silver has disappeared. It is only that it has moved from owners who hold it for commercial purposes to owners who use it for decoration.
Silver users are not fools. They have more incentive to monitor statistics relating to silver than almost anyone else does. Yes, they have bid up the price of silver since April 2003, when it bottomed for the year at $4.37. Silver has had a nice move upward. But let us not mistake a move that was preceded by gold’s move by two years as some sort of alarm bell on an imminent shortage of silver.
Here is my main point: I have heard this same argument about silver’s imminent shortage ever since 1973, when I sold silver for a living. All through the early 1980's, silver guru (emeritus) Jerome Smith told people in a series of books that $50 silver was only the tip of the iceberg, that silver would be at $100 an ounce by 1986, and on and on. It was all nonsense. Silver was headed for $3.60.
When a wise man hears the same argument used over and over, decade after decade, to buy silver, yet the price only once has moved far out of a trading range of a few dollars, then he grows suspicious every time he hears the argument.
GOLD IS A SAFER BET THAN SILVER
I am a gold bug. This means that I believe that the dollar price of gold will eventually rise, because the purchasing power of the dollar will decline by a much greater percentage than is presently expected by conventional investors.
Price inflation alone will not drive up the price of gold or silver, as we can see in the prices of both metals after January 1980. There was steady price inflation and also a price collapse of both metals for two decades. Unexpected price inflation is the deciding factor.
I think the economy is getting closer to a recession. So, I think silver — an industrial metal — is more vulnerable to a decline in price than gold is, which retains its status as money for central banks.
I warn everyone not to accept as proven the assertion that the alleged decline of inventories of silver in bar form is the same as a decline in the above-ground supply of silver. There is a transfer of silver going on: from professional speculators (few) to users (many). There are also inventories held in bar form by silver users.
Decade after decade, part-time silver speculators (readers of newsletters) have been assured that silver is running out, that a shortage will soon emerge, and prices will go up.
From 1792 to 1972, this was not a problem. Bunker Hunt came and went. Then silver’s price collapsed back to the level it had traded in since 1792.
Don’t get your hopes up for a killing. Some profits, yes, but not until after the next recession. Is it better than owning fiat money? A few thousand dollar’s worth, yes. You have probably heard that Warren Buffett supposedly owns all that silver that he bought in 1997: 139 million ounces. But, as a percentage of his wealth, this is peanuts. It is worth noting that this investment performed poorly for five years after he bought it — one of the most well-publicized clunkers in his career. Finally, he probably leased out 50 million ounces.
I have seen it all and heard it all since 1962, and I even participated in 1973 as a silver salesman. Silver is always running out. A new generation of part-time silver speculators is always lining up.
CONCLUSION
Easy Street is not paved with silver, contrary to William Jennings Bryan in 1896, 1900, and 1908; Bunker Hunt, 1973-80; and Jerome Smith, 1982-198?, who has long since disappeared. There is a time to buy and a time to sell. When recessions loom ahead, it is best to sit on the sidelines unless the FED is pumping hard (as it is today), or unless a major terrorist attack occurs in the United States, or unless some nation bombs Iran. None of this has much to do with an alleged imminent shortage of silver.
Originally posted on February 15, 2006.
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The originals are here: Part 1, Part 2.
Price of silver on February 5, 2006: $9.78
Price of gold on February 5, 2006: $570
Price of silver on April 5, 2019: $15
Price of gold: April 5, 2019: $1291
Percentage increase in the price of silver: 53%
Percentage increase in the price of gold: 126%