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Sunday, December 16th, 2018 - Buy Gold - Bringing you trusted gold news and gold investing information since 2006

Rebalancing Silver and Gold Weights Within a Precious Metals Allocation

We recently published a short article presenting the 20-year history of the ratio of the price of silver to the price of gold, and our portfolio action in response to that data. It was quite totally trashed by the comments.

In two days, it was read about 7,200 times and some 75 people left comments that were as strongly negative as any we have had on any article published in the past five years. We think we struck a nerve in the gold/silver bug community.

So, this is a follow-up to that article which may possibly seem less unacceptable to some, and in which we’ll give our detractor’s views full recognition.

What We Said:

First, the data which so offended so many is that the current ratio of the price of silver to the price of gold is higher now than it has been in the past 20 years. We pointed out that we own both silver and gold, but that we are reducing our silver holdings.

We said silver was not the long-term place to be, and should have said that we hold that view because of silver’s industrial use sensitivity versus gold’s more pure money alternative status.

We have reduced silver in favor of gold. That is a basic rebalancing concept — taking some off the top of those assets that do better, while committing more to those assets that lag — a reversion to the mean concept.

What They Said:

For some reason, a number were uncomfortable with a silver-to-gold ratio, because the convention they use is a gold-to-silver ratio.

Of the substantive comments, there were primarily two types.

One type felt that a 20-year history was not appropriate, and that instead a 100-year, 200-year, 500-year, 1000-year history, or even a view back to the Roman Empire, was appropriate to understand and interpret the ratio of the silver price to that of gold. That, they pointed out, would make the ratio difference between current prices versus the last 20-year average irrelevant.

A second type asserted that with a finite amount of silver on earth, and a rising demand, that someday the supply-demand squeeze would cause the price of silver to rocket upward, making the ratio of the price of silver-to-gold irrelevant.

Another non-substantive type, simply stated that in the long-run silver had a long way to go up, this making the ratio of the price of silver-to-gold irrelevant.

There was, of course, the fourth argument found in most long comment threads on any article by any author on any topic, asserting without any supporting information, and typically in a hostile manner, that entire article was simply rubbish.

Lastly, and perhaps only to be found among precious metals cultists, some suggested that the article was part of a short-selling conspiracy attempting to profit by driving down the price of silver. How delusional would a non-institutional, non-celebrity author have to be to believe that their voice could move the market for a global commodity?

What We Believe Is Reasonable:

We believe it is definitely interesting to study patterns that occur over centuries or millennia, and to be aware that is it possible that long-tailed history like that may come full circle.

We don’t believe that making an asset allocation and quarterly, semi-annual or annual allocation rebalancing decision should be based on 100 years or 1,000 years of price behavior.

We believe that there is a recency bias in the behavior of prices, and that the relationship of prices over months, quarter and years is generally a better guide to allocation than looking back to ancient times.

We own both gold and silver (although much more gold than silver) and did not suggest having none of either. Rather we suggest trimming the silver position to add to the gold position, keeping the precious metals allocation the same and the target allocation between them the same. That is probably a safer thing to do than to attempt to ride the silver bullet train to the top.

The silver price is increasing at an unsustainable rate, which historically for any security tends to precede a strong correction. Gold on the other hand has been consolidating, which we think gives it a firmer foundation for a potential next leg up.

So, if that belief and action on our part is foolish or nonsense or absurd, then we stand guilty as charged. We are resolute in our belief that our rebalancing is at least reasonable, even if it ultimately proves not to generate the highest return — because we believe it has a better risk/reward profile.

Longer History — Since the US Went Off the Gold Standard:

For practical purposes, making allocation decisions with a 3 to 6 months time horizon, we think there is no need to look back beyond the 40 years since 1971, the year the US went off the gold standard.

This chart shows the silver-to-gold price ratio since 1971. We think the 1979 ratio should be ignored as it was a buying climax manipulated by the Hunt brothers attempt to control the silver market. However, that year might be a good example of how vertical price moves tend to resolve in an equally stunning collapse.

click to enlarge images

The average silver-to-gold price ratio since going off the gold standard has been 0.019. The ratio now is 0.025.

The stagflation years ending in the stock market low in 1974 did have a higher ratio, but we do not have similar circumstances at this time.

If we are wrong in our assessment and approach, we will not suffer the consequences of owning no precious metals, but rather the consequence of owning a bit less silver and a bit more gold — hardly a precarious situation.

Silver Outperformance:

Silver has clearly outperformed gold recently. As the economy showed clear signs of improvement, it rose quickly and steeply above the return on gold. Silver has a greater industrial use than gold and can respond more forcefully upward to GDP growth, or the expectation of growth, than gold.

During the period of greater uncertainty about the direction of GDP from the October 2008 crash to mid-2010, silver and gold tended to track more closely, although silver was ahead even then. Once news became more solid about the economy in the second half of 2010, silver took off — but is much more volatile.

The next chart shows the same pattern of silver outperforming gold, particularly in the recovery years after the 2003 stock market bottom, up through the heady days of 2007. However, when the 2008 credit crisis hit, silver completely fell out of bed and declined by more than 1/2 — like stocks. Gold took a lesser hit, and then continued upward.

It appears to us that silver is even farther out ahead of gold now than it was in 2007, and it also appears that the world economy may not be growing or expected to grow as fast in the next year as was the case a few months ago.

In a stock market correction, silver could experience a substantial decline. A stock market correction has a significant probability with all that is going on in world today.

Therefore, we think harvesting some profits from silver and reinvesting them in gold is a reasonable play within the precious metals category.

We’d rather ride the next 3 to 6 months on gold than silver. To us gold has a lower risk and still a high enough return potential for our purposes. We don’t try to shoot for the moon, just to keep a sold mix and balance.

Related Securities: SLV, DBS, SIVR, GLD, IAU, SGOL.

Disclosure: We hold GLD in some but not all managed accounts, and some SLV in some accounts which we are reducing in favor of GLD, as of the publication date of this article.

Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advise to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on our site available here.

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