Which would you prefer, a diamond or a sapphire? (sapphire) Which would you give your wife, gold or silver (silver)? Despite the fact that gold reached that $1000/ounce threshold last week, the yellow metal is still far away from its all time inflation adjusted high back in 1980, ($850/ounce in 1980 dollars) according to this article, that would be the equivalent of $2177/ounce in today’s dollars, though it only hit that peak for one day back in 1980. We have been asked several times to comment on where we feel the gold and silver markets are headed. In short, we do believe that gold is likely to rise still further as investors (and speculators) tend to put their money in gold when the dollar falls (and oil is high). Given the overall economic picture, we believe many speculators are moving their dollars to commodities in general and hence prices are still increasing. We’ll get to silver in a minute.
The commodity markets these days trouble me because good old fashioned supply and demand do not seem to have much of an impact on price. Simple microeconomic theory would suggest, “that in a competitive market, price will function to equalize the quantity demanded by consumers and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity,” according to Wikipedia. But that does not seem to be happening for base metals, steel or precious metals. And it is particularly not happening in the case of gold. In fact, since gold is basically used in jewelry, it is mostly “held” (as opposed to consumed). In fact, only 12%, or 400 tons according to this Industry Week article of the world’s gold is used in industrial applications, mostly dental and electronics. That said, demand for gold will likely increase due to new applications such as nano-scale electronic applications and nano-wires and nano-devices.
But let’s get back to this point about being “held” vs. “consumed” ” gold inventories are at 5 billion ounces according to this article (from a silver analyst) And as we have been discussing, “supply” is not the only relevant factor in determining price. We have rarity, popularity, and market mechanisms. Yet gold is the world’s security blanket as most central banks still own gold and consider it a monetary asset.
So what is our price prediction? Gold will still go up as long as the Fed keeps pushing the dollar lower. And folks will still flock to gold during this period of economic uncertainty. Once the US economy stabilizes and the Fed moves interest rates in the other direction, I would expect gold prices to come down. There certainly does not appear to be any massive new demand for gold from an industrial applications perspective. Furthermore, gold stocks are not in tight supply. Prices have increased by 23 percent since the beginning of this year. So, in the short term, I would expect gold to still go up somewhat but over time, prices will come down.
But silver is altogether a different matter. Of the 911 million ounces of silver produced in 2006, 575.8 million ounces were used in industrial applications and photography. In other words, industrial applications for silver equate to more than 60% of the total, compared to gold’s 12%. Silver inventories are only one fifth that of gold or 1 billion ounces Gold is used in several industrial applications including automotive emissions, electronics, medicine and nanotechnology. Silver is used for soldering to achieve ROHS compliance, electrical contacts and conductors, mirrors, photographic film and disinfectants, as examples. If one were just to look at the supply and demand curve for silver, one might easily conclude that the price of silver has only one way to go and that too is up. But here is where it becomes more complicated and luckily there are many bright investment analysts out there who explain these theories more succinctly than I.
According to David Morgan, a noted silver analyst, silver is poised to continue its rise upward for a host of reasons but the ones most intriguing include, “The US was in far stronger financial condition in 1980 than today” and “Monetary worry was primarily US based in 1980; today it is a world wide concern” Morgan, in this thought provoking article creates a methodology to forecast the price for silver by using a ratio which was used when gold and silver were both used as monetary instruments. This ratio was between 15-16: 1 – meaning one ounce of gold equated to 16 ounces of silver. Today that ratio is more than 50:1. But several analysts, including Morgan, believe the ratio will return to the 16:1 level and that would mean silver would significantly outperform gold.
Since we aren’t investment analysts running sophisticated forecasts and algorithms (though one day soon we may just do that), we little buyers have nothing else to do but look at the market fundamentals and that’s why I’m calling it…silver is going to outperform gold.