SILVER IS MUCH CHEAPER THAN ANYONE REALISES / MACLEOD FINANCE

Silver is much cheaper than anyone realises

Severe under-valuations of base metals priced in gold point to far higher prices for them when they normalise. This is driving a significant rerating for silver.

Alasdair Macleod

Summary and conclusion

In this article I examine the prospects for silver relative to gold, not from the customary gold-to-silver ratio but on the assumption of its use-value as an industrial base metal. 

I find that the entire base metal basket is more undervalued than it has ever been in gold terms since 1900, and almost certainly during the industrial revolution when base metals began to be more widely used.

Acting as an industrial metal with no monetary premium, silver appears to be in the earliest stages of correcting this severe undervaluation, outperforming its base metal peers at a time when the purchasing powers of the dollar and other G7 currencies are beginning to decline at an accelerating rate. 

The bullish case is fully justified, and almost certainly silver’s price potential relative to gold and in fiat currencies is greatly underestimated.

The historical background

It is over 150 years since silver was valued as metallic money, when Germany and other European nations abandoned it as their monetary standard in favour of gold. 

Ever since, silver has been valued as an industrial metal, more in common with base metals than gold.

The price of silver still has a long way to climb before it can be said to reflect any value as metallic money. 

Silver bulls have its history of monetary status as their lodestar, but on close examination it is even undervalued as an industrial metal, a position which it is only starting to correct.

Before we consider why this is so, we must first assess the prospects for gold. 

Gold bugs are unequivocally bullish, but they always promote positive evidence for their cause. 

Perhaps their cheerleading suggests that their vociferous bullishness is overblown and a correction to shake out flaky bulls is overdue.

But we should bear in mind that in the wider investment context precious metal enthusiasts are actually in a miniscule minority. It’s estimated that investment funds globally amount to about $270 trillion (MSCI, 2023), the bulk of which are regulated, and physical gold is not a regulated investment. 

Physically backed gold ETFs which replaces bullion, technically not actually gold but gold substitutes, total 3,445 tonnes currently worth $370 billion which is only 0.14% of total investment funds.

Of course, there are unknown quantities of unrecorded bullion held. 

These are inactive holdings as part of personal wealth held outside the investment industry’s statistics. 

The point is that globally gold is hardly owned at all in regulated portfolios, and the global investment industry has yet to invest.

Despite this, gold has risen substantially in recent years, priced in declining fiat currencies. 

In conventional terms, we would say that investors have yet to pile in, certain to drive gold far higher. 

But that wrongly assumes that gold is an investment. 

The error is to compare incorporeal credit instruments such as currencies and derivative investments with corporeal money in common law without counterparty risk. 

The true relationship is actually one of an escape from credit into security; and credit includes fiat currencies issued by central banks as government departments.

The correct way to regard gold is as the ultimate hedge against currency risk. 

Therefore, the currency quantity per gold ounce as the way to describe the relationship should be expressed the other way round, which is actually how gold standards were always expressed in law.

Therefore, by inverting the familiar gold chart, we can illustrate the true relationship:

It is notable how the dollar’s decline has accelerated, particularly over the last 30 months. 

Far from being a bullish gold chart, we can see that instead it is a very bearish chart for the dollar. 

What matters is not whether the gold price is too high, but what will the US authorities do to stop the dollar declining further.

Prices expressed in gold are remarkably stable

The long-term evidence over many centuries is of price stability for commodities and common items measured in gold. 

While there is variation in individual items, in a widespread basket of commodities and goods the purchasing power of gold is remarkably constant. 

By way of explaining this phenomenon, we should note that gold is universally accepted as final settlement extinguishing all credit. 

And for as long as we have reliable records, above ground quantities of bullion have grown at a similar pace to the world’s population.

The next chart demonstrates the relative stability of gold as a pricing medium, showing the price evolution of a basket of base metals listed in the box since 1900 in both gold and US dollars.

Since 1934, dollar debasement has led to prices indexed at 1.00 in 1900 increasing 2800% to date with considerable volatility along the way. 

Meanwhile, priced in gold the basket of base metals has been extremely stable.

The next chart looks at the relationships between the basket and gold in more detail.

It should be noted that under a gold standard, a widely used currency such as the US dollar has the ability to distort pricing in gold by dragging gold up or down with it, or in the case where the standard is maintained by buying or selling bullion into and from reserves lowering or increasing commodity values priced in gold respectively. 

These distortions have played a major part in varying gold’s purchasing power since 1900, which should be borne in mind with respect to the comments which follow:

1. Valued in gold, the value of the basket jumped 148% during the First World War. 

At that time, the dollar was on a gold standard at $20.67 per ounce. 

By 1921 it had returned to 1900 levels. 

The expansion of dollar credit and subsequent post-war slump dragged gold’s purchasing power down and then up (metals prices first higher then lower) through the currency’s link with the gold standard.

2. The Fed’s 1920s credit expansion led to prices rising by 42% by 1927, a level broadly maintained until the Wall Street crash, Smoot-Hawley tariffs, and the developing slump undermined commodity values. 

Again, the dollar dragged gold’s purchasing power down and then back up when credit was extinguished by the slump.

3. At the end of 1933, the index was back at 1. 

In January 1934 the dollar was devalued to $35 and by 1935 the index had fallen to 0.75 while the dollar rate (not shown) rose to 1.18. 

Base metal values in gold then rose by 155% to 2.55 by 1951 with a secondary peak in 1956. 

In effect, base metal prices were set in dollars whose money supply had increased substantially, pulling the purchasing power of gold down by virtue of its link through the $35 gold standard.

4. After falling back to 1.60 in 1958, the index rose to 2.58 in 1970, an all-time high. 

While US money M3 supply more than doubled between 1958—1970, US gold reserves almost halved to 9,839.2. 

It was only by selling down gold reserves and effectively suppressing the gold/dollar rate that the dollar maintained the peg and prevented devaluation, actions which effectively devalued gold relative to the dollar instead.

5. Bretton Woods was abandoned in August 1971. 

Freed from the dollar’s suppression, gold’s value rose, reflected in a fall in the index back to 1900-levels in 1974 before sinking further to 0.48 in 1980.

6. Gold then entered a bear market against the dollar, taking it down from a peak of $850 in 1981 to $257 in 1922. 

After briefly recovering to 1.0 in 2008, following the Lehman crisis the base metal index in gold resumed its decline to 0.23 currently, which is 77% below its level in 1900.

What now for base metals?

With a gathering crisis for the dollar pointing to higher inflation, recession, and rising bond yields, the downside for gold priced in dollars is almost certainly very limited. 

Yet, in an historical context the prices of base metals are exceptionally low measured in gold. 

Looking ahead, the Asian hegemons backed by members of the Shanghai Cooperation Organisation and a growing BRICS already account for the majority of the global population and on purchasing power parity estimates about 40% of global economic activity. 

The dollar’s dominance and the G7’s economic influence on commodity prices are both declining.

The rapid industrialisation of this new emerging world will ensure continuing and growing demand for base metals. 

Therefore, we can expect their values priced in gold to return towards a norm, closer to 1.00 on the index. 

That represents a tripling of prices relative to gold on average. 

But as pointed out at the beginning of this article, relative to the dollar gold is also set to continue rising as the dollar’s purchasing power and the faith in it as a fiat currency continues to decline. 

Therefore, over time a quadrupling of base metal prices measured in gold should be regarded as a minimum.

Silver is being turbocharged as an industrial metal

On the evidence presented in this article, without any monetary considerations and as an industrial metal silver is starting to recover from an extreme undervaluation. 

This is beginning to be reflected in the gold/silver ratio, which has declined from an all-time high of 121 in March 2020 to 87 currently. 

Putting silver into a base metal context is the subject of my final chart. 

Both the base metal basket and silver priced in gold are rebased to 1.00 in 1978, when the metal basket had the same value as in 1900, the basis of the previous two charts.

Besides the silver spike in 1979—1980 when the Hunt Brothers tried to corner the market, silver has correlated reasonably with base metals valued in gold. 

In the last two years, it has begun to outperform the base metal index, probably reflecting the general flight out of fiat currencies into gold.

This recent outperformance relative to base metals suggests it is only in the very early stages of being recognised as a monetary metal. 

But from an undervaluation relative to gold of 67%, silver should at least double from the current level at $38 with gold at $3350, before there would be any theoretical premium as a monetary metal in the price.

Conclusion

In this article we have examined the prospects for silver relative to gold, not from the customary gold to silver ratio but on the assumption of its use-value as an industrial base metal. 

The entire base metal basket is the most undervalued it has ever been in gold terms since 1900, and probably in industrial history.

Silver appears to be in the earliest stages of correcting this undervaluation, outperforming its base metal peers at a time when the purchasing powers of the dollar and other G7 currencies are beginning to decline at an accelerating rate. 

The bullish case is fully justified, and almost certainly wildly underestimated.