Michael Noonan: The magic of compound interest is well known. What is lesser known is the magic of the gold/silver ratio, not as a measure as it is mostly viewed, but as an application for increasing one’s holdings substantially, over time. What is so great here is that no magic is involved, rather simply utilizing the market to more than double your holdings.
So-called “Gold Bugs” are considered ardent supporters of the PM [Precious Metal]. Silver stackers are just as avid. Then there are those willing to buy either or both. The chart below is the gold/silver ratio going back 15 years, and this is a hindsight analysis brought forth to the present tense for future consideration that can greatly increase net holdings at almost no cost, those being transaction costs from a dealer.
Consider three investors: 1. a gold-only buyer who loves gold. 2. a silver-only buyer who loves stacking. 3. A buyer of either or both and who wants to maximize what he [she] owns. [Transaction costs are not considered, and some rounding off may occur].
Buyer 1 bought 20 oz of gold in 1995 for $380 the ounce, or $7,600. Buyer 2 bought 1,000 oz of silver at $4.30 the ounce, or $4,300. Buyer 3 bought 20 oz of gold because the gold ratio favored holding gold, at the time. Buyers 1 and 2 safely stored their PM, relying on over 5,000 years of history that could increase the value of what they owned.
Sure enough, by 2014, buyer 1′s 20 oz of gold are presently worth a tidy $26,000. Buyer 2′s silver is now worth $20,500. Both have done well and are pleased with what they have. Buyer 3 had something different in mind, and that was to put the market forces to work in his favor and at no risk to his holdings. In what is to follow, there are no right or wrong decisions, just some that work better than others. Buyer 3 decided that at 80:1. gold over silver, silver would likely do better than gold, strictly from a gold/silver ratio perspective. Price was of no consequence for he was not selling his holdings, just switching from one to the other.
Buyer 3 decided to take his 20 oz of gold and exchange them for silver when the gold/silver ratio was at 80:1. 20 x 80 = 1,600 oz of silver exchanged from gold. He saw that 50:1 was strong support and favored gold to outperform silver. In 1999, he switched his 1,600 oz of silver back into gold. 1,600 divided by 50 = 32 oz of gold. Not bad. Now his original 20 oz of gold became 32 oz, irrespective of market price. It was the relationship between the two that mattered.
Around 2003, the ratio expanded back to 80:1, and his rule to switch from gold to silver came back into play. His 32 oz of gold x 80 translated into 2,560 oz of silver, giving him an added 960 from his last switch. Just like buyers 1 and 2, buyer 3 was at no risk of loss because he was always invested in one metal or the other.
In 2006, the gold/silver ratio declined back to 50:1, and that was buyer 3′s signal to take his 2,560 oz of silver and turn it back into gold. 2,560 divided by 50 = 51 oz of gold. His original 20oz became 32 oz, and now he had 51 oz. Price was immaterial to his plan.
In 2009, the gold/silver ratio hit 80 again, and buyer 2 put his plan back into action, switching his 51 oz of gold into 4,080 of silver. His application of the “magic” of the gold/silver was working as planned, according to a few simple rules, his 80/50 rule, we will call it.
A few years later, in 2011, when the gold/silver ratio came back to 50:1, buyer 3 was ready. He took is 4,080 oz of gold and switched them for 81 oz of gold. All he did was observe where support and resistance were in the gold/silver ratio. It did not bother him in the least that the ratio went as low as 35:1 before turning back up. His plan and his rules for implementing it were more important than trying to outguess the market.
One thing he did observe was how the gold/silver ratio kept stalling at 68 area. Things change, like his original 20 oz changing to 81, and maybe the gold/silver ratio was in the process of change? Like we said, there are no right or wrong decisions, just some that work better than others. With that we are now in the present tense.
Buyer 3 has a decision to make. Wait for the 80:1 ratio, or recognize the possibility that the current 63:1 may be worth taking some action and switching because 68:1 has become resistance over the last 4 years. Buyer 3 could chose to hedge his bet, as it were, and just switch half of his gold holdings into silver at 63:1.