-- Posted 23 August, 2006 | |
By Chris Weber
This is written with some trepidation. Silver is much more volatile than gold, and forecasting it is fraught with peril. Nonetheless, I think it is important to have some goal or target in mind when you take a position in an investment. Over the past few years I have taken a major position in silver, so I want to take this opportunity to think my way through where I think it could go, and how long it could take to get there.
I want to explore this from a number of ways. First, I'm going to use the same approaches I previously did for gold. But then, I want to discuss the important area of the silver to gold ratio.
My first "target" was to see a process, Like gold, I wanted to see silver rising in terms of all major currencies, and not just the US dollar. This happened last year. It was clearly the world's strongest currency of 2005. It rose by 29% against the US dollar, but against the Japanese yen it was up 46.9%, against the euro 47.7%, and it soared against the Swiss franc by 48.6%. So clearly, even though it is rarely talked of in these terms, this process of silver being a strong currency has clearly been underway for quite some time.
The 50% Principle
Last October the gold price was $470. I said then that the second thing I wanted to see was how gold would handle the $550 mark. This was the level which represented a retracement of 50% from the highest point it reached in the previous bull market ($850) to the lowest point it got in the bear market ($250).
After a huge move in one direction ---like the 20 year gold bear move from $850 to $250-- an asset will rise again and it may rise strongly enough to test the level that represents 50% of the previous move. We see an important indication of the strength of that new move in how it handles the half-way point in the previous fall. The way it handles this often makes the difference between a "dead cat bounce" and the confirmation of a new bull market.
For gold, the price moved up fast but it stuck at the $550 area. For a while it battled with it, but gold finally broke through this area and itís now around $625. That's a good sign for its future.
But what about silver? Can we use the same idea there?
On January 21, 1980, silver's London fix price was $49.45.It has never been higher. From there it began a plunge that would take it to a low of $3.5475 at the end of February, 1993.
That was a plunge of 92.8% in just over 13 years.
You really can't say that the bull market started back then in 1993, but at least it never fell lower. For the next nearly nine years, it lay as if near dead from that huge fall. In November of 2001, silver touched $4.07.
We can say that here began the current bull market in silver. However, if you are trying to apply the 50% principle, you use the highest point and the lowest point. In gold's case, the low point more clearly coincided with the approximate start of the new bull market. In silver's case it did not. Lots of years came and went first.
However, for our purposes, it really doesn't matter. The 50% mid-point between $49.45 and $3.5475 is $26.49875. Let's call it $26.50. But even if we use the start of the bull market, the 2001 low of $4.07, we find it doesn't make much difference. The mid point between high and low this way is $26.76.
On January 21, 1980, the London fix reached $49.45. But later in the day, the US market cash price never reached that high. It went only to $48. Taking this as the high, and the $3.5475 for the low, you get a 50% point of $25.77. Or with the $4.07 low, $26.04.
So taking all these figures together, I'm going to say that the 50% retracement level for silver is $26. Going from this, we can expect silver to test the general area from $25 to $27.
This is my next target for silver. However, I want to give silver a lot more leeway than gold.
We've seen how volatile silver's moves can be. In 1997 Warren Buffett became convinced that silver was extremely cheap ---it was then $4.40--- and bought 100 million ounces. As he did, the price soared to a high of $7.31 in early 1998. Later of course, the price fell back. By November, 2001 it reached $4.07. Buffett held fast and has been amply rewarded, as he usually is when he invests. Many people buying some silver near $7.31 and watching it fall by 44% over the next nearly four years would likely bail out, especially when so much else was soaring from 1998 to 2000.
I don't know the exact prices Buffett paid, but the very fact of him buying vaulted the price.
Before that, during the 1970s the Hunt brothers also became convinced that silver was cheap and started to buy. As it rose more they bought more. Finally, in 1980, they were accused of trying to "corner" the market.
They were true believers in silver, and unlike Buffett, kept buying even as the price soared.
The idea of cornering any market is something I wonder about. Can it really be done? To corner a market means to buy most or nearly all of it up. But though you can try this, the price gets progressively higher as you go along. Whether the Hunts were trying to corner the silver market or not, the fact is that they ---and many others like them--- bought more of it the higher it went. At last, the price was far too high. But not to the buyers: with silver at near $50, I remember a major silver "guru" telling me it would go to $100, and he was buying even more. But finally market reality takes over, and the price falls. Those who bought but did not sell are hurt badly.
To me, that's not the way to do things. I prefer the Buffett way. You become convinced that something is cheap, and you take a big position: big for you at any rate. Then you wait. And when you see everyone else trying to get in, you sell.
That this is the better way is proven by the fact that Buffett is still going strong. The Hunt brothers were broken by their experience, as indeed --sadly-- was my friend, the silver guru.
So keeping in mind that silver's moves are much more wild than gold's, I think sooner or later we will see silver approach the $25-$27 level. If it breaks above this, then the next target would be the old highs of 1980.
But $50 in 1980 is not the same as $50 in 2006. And even though I think silver will once again trade at $50, this may not be for years ---perhaps not for five years, or until 2010, who knows? And if so, who knows how much $50 in 1980 terms would be in 2010 terms?
All we can say is how much it is in 2005 terms. Using the Inflation Calculator (http://www.westegg.com/inflation/infl.cgi) we see that $50 in 1980 equaled $126.98 in 2005, the latest year for which you can do this. Using the actual London high of $49.45, we get $125.59.
This is a way of saying that even if silver reaches its old high of around $50, this would still be very much lower in real terms than it was at the peak. And remember, that this real term level of $126 is based on 2005 dollars. Let's say that silver reaches $50 in 2010. It could well be that the price level in 2010 is 50% higher than it was in 2005. If so, then $126 in 2005 would be $189 in 2010.
I have no way of knowing if silver will reach $50 in 2010, but I'm showing that if it does, it could still be cheaper in real terms than it was in 1980. And I can certainly say that even if silver reached $50 per ounce next month ---which I don't expect--- it would be cheaper in real terms than it was the last time it reached that level. Based on the inflation of the dollar as of now, it would have to be about $130 to equal what it was at the highs.
In fact, silver at $50 this year would translate in real terms into less than $20 in 1980 terms. And even with silver at $12 in today's dollars, this is less than $5 in 1980 dollars, or about one-tenth the price it briefly reached.
During silver's last bull market it went from $1.29 to $49.45. That was a rise of 3,733% in just over 10 years. You can say that the $1.29 price of the 1960s was artificially low by government control; it was the "official" price of silver. We don't have an official price now. But what we do have is much worse levels of debt and other factors that counterbalance what we had then.
However, if we take the low of $4.07 and assume that this bull market is only half as strong in percentage terms as the old one was, that's a rise of 1,867%, or $80. So I think that $80 is a conservative target for this bull market, not even considering the difference in real dollars, discounting for inflation. Of course, it has to get past the $26 level first!
Gold at $3,000 Equals Silver at $187.50
When I recommended silver in 2004, I said that it could rise by 2,785% from the level then existing. This meant a price of $187.50. I got this by thinking about the gold/silver ratio.
For the reasons I put in that issue, my price target for gold was and still is $3,000 by 2020. And 3000 is 16 times 187.50. Why did I pick 16? You can see why when you know about the history of the gold/silver ratio.
Throughout the last several centuries, a ratio of silver's value to gold's has always seemed to come back to the 16:1 area, where about 16 ounces of silver equals one gold ounce.
Granted, there have been extremes in the market at certain times. At one extreme was the London market ratio of a mere 6:1 in the first quarter of 1551. Never again was silver valued so highly compared to gold. The reason was that newly discovered Spanish gold was pouring into Europe. While both gold and silver were discovered in the New World, the Spanish naturally focused on gold, it being more valuable. But so much gold came, relative to silver, that silver became relatively more valuable. This extreme in the market, like all extremes, was not to last long. Later that same year the ratio doubled to 12:1.
The other recorded historical extremes came much more recently. It reached over 100 to 1 in the early 1940s, but the metals markets were not freely functioning with the world at war. On February 28, 1991, the ratio also reached 100.35:1. At that rate, silver was amazingly lowly valued against gold. This extreme proved equally untenable, and silver began to gain on gold in the next few years. On February 28, 1998, exactly six years later, the ratio stood at 40.92:1. But the normal ratio for most of the past few centuries has been in the range of 14 to 16:1.
For centuries, governments had a bi-metallic standard, with both silver and gold as money at an official ratio between them...nearly always in that 14 to 16:1 area. But this came with a lot of problems. Or should I say just one big problem. The market ratio was not always the same as the official ratio. One time or another, silver became overvalued in relation to gold, or vice versa. Let's say the ratio was set at 16:1. But then the market rate went to 15:1. This made silver actually more valuable than it was officially acknowledged to be.
How did people react to this? The money that was undervalued by the government went into hiding or left the country. We've seen this happen many, many times in the recent past. In 1965, the US removed all the silver from its dimes, quarter and half-dollars. For a brief while the pre-1965 silver coins circulated side by side with the new 1965 coins. But very soon the silver coins became held back by those who owned them. After all, if the government says that a quarter filled with silver is worth the same as a quarter filled with copper, the government is wrong.
Silver is worth more than copper and it always has been. Who in their right minds would spend a silver quarter on something if they can spend a coin with the same face-value filled with base metals? So in short order, the pre-1965 coins were withdrawn from circulation and held in private hands.
What History Tells Us
When the time came to establish an independent American currency the founders were very careful to establish a gold/silver ratio that exactly dovetailed with the current market price. Thus, the Coinage Act of 1792 established the US dollar and defined it officially as a weight of both silver and gold. Specifically, it was defined as 371.25 grains of pure silver and/or 24.75 grains of pure gold. This was a ratio of 15:1. Anyone could bring silver or gold to the new Philadelphia Mint to be coined, and silver and gold were both legal tender at this 15 to 1 ratio. The basic silver coin was the silver dollar and the basic gold coin was the $10 Eagle.
Now I want to show you a fascinating chart. It is the history of the gold/silver ratio in terms of the US dollar, since its 1792 founding to today.
As you can see, from 1792 to the Civil War in 1861 the ratio looks roughly stable. But there was a wealth of problems with it that the chart does not show. Because in fact, this ratio might have reflected the market prices of both metals in 1792, but market values, as we all know, change. And change they did. In fact, from the late 1780s through the next 30 years, Mexican mines began to pour out huge amounts of silver. The result was that the market ratio fell.
It doesn't take a rocket scientist to see what happened. Silver was actually cheaper relative to gold than the US government "said" it was. Gold was undervalued and gold coins began to disappear from the United States as silver coins from all over the world began to flood in, since the US government was obliged to buy them at a price 5% over what the world market price was. It was a great way to make a quick little profit, so much more because the European monetary system was changing to reflect the market values of their own times.
For instance, in 1803 Napoleon established the Bank of France to stabilize a franc that had been ruined by the paper money inflation of the Revolution of the 1790s. Reflecting the new market ratios, he set the ratio at 15.5:1. Then, in 1816, when the British went back on the gold standard after the wars with France ended at Waterloo in 1815, they reflected the market at that time and chose a 16:1 ratio. With America still on a 15:1 ratio, overvaluing silver relative to gold, by 1810 and for years after, the US was left with virtually no gold coins. These coins went instead to places which valued them more. Sharp speculators could buy gold officially in the US and sell it in London for a gross profit of 6.7%
To make matters worse for the Americans, Spanish silver coinage was allowed to circulate alongside US coinage. But the Spanish silver dollars contained from 2 to 5% more silver than the US ones did. So it paid to take the heavier Spanish dollars to the Mint, have them melted down, pocket the profit, and repeat the process. Very soon only American silver dollars were left in circulation.
That meant that after 1810 America's monetary system was in a mess. This was to prove ruinous in the War of 1812. Not enough silver and no gold circulated, so individual banks printed paper money to finance the war. This caused horrible inflation. Prices soared by an average of 50% during the war. Worse, after August, 1814 banks did not have to pay out gold or silver at all if people holding the paper money came to ask for it. This act exacerbated the inflation, which in turned caused mal-investments (as it always does). And this resulted in America's first Depression, the Panic of 1819. The month of August, 1814 was a terrible one for America. This was the month where an invading British army entered Washington DC and burned the White House and Congress to the ground.
But our story is the gold/silver ratio here. Monetary chaos and inflation continued through the 1820s, until Andrew Jackson (1829 -1837) decided to do something about it. The Coinage Act of 1834 changed the 15:1 ratio to 16:1, better reflecting market realities. (You can see this on the chart.) There was one problem with the way this was done. Instead of up-valuing silver they de-valued gold. The gold dollar was devalued by 6.26%. The silver dollar was left as it was. This was a populist move: the cry went around the land to "leave the dollar of our fathers" alone. It would have been better to re-value silver upwards rather than gold downwards. This 1834 devaluation of the gold dollar set a bad precedent that would come back to haunt America exactly 100 years later. But things went well and for the first time since the 1790s, America had plenty of gold and silver coins circulating.
But then came 1848. Gold was discovered in California in huge amounts. A few years later, gold was discovered in Victoria, Australia and Russia. All this new gold coming in cheapened it in terms of silver. The gold/silver ratio declined from 15.97 in January 1849, when the first '49ers arrived in San Francisco, to an average of 15.37:1 from 1853 to 1860, but this caused a problem. Silver left the US and with no small change and only larger value gold coins available, lots of new paper money was issued by banks in smaller denominations.
This near-constant headache was starting to tire Americans. Either gold had disappeared, or silver had, or sometimes both had. There had to be a better way. The days of the official bi-metallic standard in the US were numbered. A choice had to be made to either monetize one metal or the other. The one not made the official money would still circulate by weight. The wealthy and powerful wanted a pure gold standard, with the dollar defined in gold alone, with smaller silver coinage freely circulating by weight.
The Civil War intervened, giving America more to worry about than coin shortages. But a few years after the war, the "gold lobby" struck.
You see on the chart how after 1872 the ratio starts to soar out of the 14-16:1 range. In 1872 it became apparent to a few smart investors and even some wise officials in the US Treasury that the ratio, which had held steady at about 15.5 to 1 since 1861, was about to change drastically. Silver was about to lose much of its value.
One reason was the discovery of huge silver mines in Nevada, recently admitted to the Union with the motto, then as now, as The Silver State. New techniques were enabling miners to get more silver out than ever before.
But savvy globally minded men saw what was going on in Europe. Briefly, silver was being dethroned as money. First, starting in 1865 the world broke up into two factions. One wanted to continue bi-metallism as before. The leaders of this group were the US and France. France formed the Latin Union with Belgium, Switzerland, Italy and Greece to have a common ratio of 15.5:1. Further, the coins of one were to be accepted by all. But the other faction, led by Britain, wanted to do away forever with official ratios and go straight to the gold standard, with the national currencies defined only in terms of gold. Newly unified Germany joined them, as did Russia, Holland and Scandinavia. As 1873 opened, it was clear to smart people that the Latin Union was having problems.
Silver is Dethroned: The Ratio Soars
Taking advantage of this, the gold lobby passed a law in February 1873. It discontinued the minting of any more silver dollars. A year later, another law revoked the legal tender status of any silver coin above $5. Silver was effectively demonetized in America.
The market timing was perfect, because it was in 1874 that the ratio rose above 16:1 for the first time. Silver was pouring out of the mines, and Europe was increasingly moving away from silver as official money, so they needed less of it.
The ratio now began to soar and reached an amazing 42:1 by 1900. By that time the only major countries that held to the silver standard were Mexico, which produced the most of it, and China which had long historical ties to it. Mexican silver was particularly prized in Northern China, and it made up the bulk of circulating money throughout the country. Many attempts were made to get both countries off silver and onto gold, but they failed. One in particular was made in 1903, where the Americans tried to get the Europeans to join them in buying up massive amounts of Mexican silver in an attempt to make the Chinese currency rise too much in value. The Europeans were not happy at this attempt to subsidize US exports to China. Further, they coveted the Chinese markets for themselves and wanted to stay on good terms with the Chinese government. (It all sounds like what is going on a century later.)
This failing, the US went after Mexico. They got the Mexicans to pass the Currency Reform Act of 1905, which effectively made gold coins cheaper than silver ones, and thus undervalued silver, which fled the country and stopped being produced as much. This left Mexico with a gold coin standard.
So that left China as the only major power on the silver standard. And it almost caused a war. The Western powers invaded China to put down the Boxer Rebellion in 1900. They then foisted on the defeated Chinese a bill of $333 million. The Chinese started to pay this back in cheaper silver, and this enraged Britain, Japan and the US. The Chinese saw that a switch from silver to gold would only harm their economy. They defied the West and had their own Currency Reform in 1905, which replaced the old Mexican silver no longer coming out with their own silver currency, the tael. This is a measure of silver still in use in China. In Shanghai the new Silver Exchange will trade in taels, which is 50 grams of silver. And if China ever embraces silver money again, as it might, this could be the name of the currency.
So you see how seemingly far removed history has a real bearing on today's world. But back to the gold/silver ratio, look at the chart after 1900 and you see an odd thing. Each time the ratio rises it always is followed by a decline, however short, back to the traditional ratio area.
From 42:1 in 1920 it plunged to 16:1 a few years later. It briefly soared to nearly 100:1 in 1942, as gold was overvalued at $35 per ounce during this time. Silver then began to gain in relative value again in a long wave. It is interesting that 1942 marks the start of a huge bull market in the relative value of silver to gold.
For silver, the fall in the ratio from near 100 ended when silver briefly touched nearly $50 an ounce, and gold was around $850. The actual low came on January 31, 1980, when the ratio was 14.82:1. I want to point out that this 14.82:1 ratio came at the peak of the last silver bull market. It follows the pattern in having the ratio go back to the traditional area of 14 to 16:1. (Soon after, silver began a huge bear market relative to gold, which would take it up as high as 100:1 in 1991).
Certainly you can see by the chart that the ratio has been swinging back toward silver's favor since then. It has risen much faster than gold for years now. As I write this the ratio is 51.10. It thus matches the sharp rise in silver's value relative to gold that we saw in the few years after 1942. Then as now the ratio fell to about this current level and then started to fall more slowly over the next 30 years until the big blowout in 1980, when, again, we saw the ratio as low as 14.82:1.
I think we will see this area reached again. Whether it is 14.82, or 15 or 16, I think that silver will continue to rise faster than gold and the ratio will end up, even briefly, back in this traditional area.
So if we take a more conservative 16:1 ratio, and if gold reaches a high of $3,000 during this bull cycle, this means $187.50 silver. Of course, this is just a guess at this point. Who knows where gold will end up by the time this bull market is over? It could be $4,000, in which case a 16:1 ratio would be $250 silver.
It's all rather pie-in-the-sky now. I'm content to watch and wait and see where this bull market will take both metals.
Metals: How much should you own?
I think that the precious metals are still toward the beginning of a huge bull market. And I think that silver will test the $25-$27 area at some point. If it can get above this, then I will be more confident.
I've said this before many times, but the way I like to think goes like this: I want to be able to profit from trends that I think and believe will happen. But I don't want to be hurt in case I am wrong.
Each person has to decide for himself how to play this. To anyone who asks me if it is too late to buy, I say this: I think everyone should have some gold and silver, and some mining stocks. But that exact percentage will and must differ with each individual. You should not have so much of it that you won't be able to sleep at night when they plunge and stay low for a year or more. Notice that I said "when" they plunge and not "if". Silver especially has been, and will continue to be a volatile roller-coaster. If you have too much, you will be prone to panic and sell.
So how much silver should you own? Some will find that 5% of their net worth in this area is the amount that will allow them to sleep calmly through any correction. For others, with more cast-iron stomachs who are prepared to ride anything out, it could be 50%. There are as many situations and personalities out there as there are investors. But you only have to know and be comfortable with your own.
Everything tells me that this bull market will vault gold and silver to levels unimaginable to most people before it is over. Prepare yourself both to prosper if this does happen, and not to get hurt if it does not.
Chris Weber is the editor of The Weber Global Opportunities Report. For more information go to firstname.lastname@example.org
-- Posted 23 August, 2006 | |