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Sunday, October 10, 2010

Gold/Silver Ratio

My post on "Gold Bubble?" attracted some negative E-mails. Someone insisted "You're wrong! There is a gold bubble developing!" The discussion degenerated into "Is not!", "Is so!", "Is not!", "Is so!".

Another argument for "There is no gold bubble." is the gold/silver ratio. Consider this chart.

Looking at that chart, the gold/silver ratio has actually decreased since Q4 2008, from around 80 to 65. By that measure, gold is getting cheaper.

There's a problem with analyzing the FRN-denominated price of gold and silver. You get confused between dollar inflation and a bubble. If you consider gold/$ or silver/$, there's a division by zero error.

The gold/silver ratio is (gold/$) divided by (silver/$). The '$' drops out, and you have a price quoted in terms of real money. Even if there were no State fiat paper money, the gold/silver ratio would still be meaningful.

The gold/silver ratio should be approximately the same in every country. Otherwise, someone could buy in one country and sell in the other, conducting arbitrage.

When evaluating the gold/silver ratio, it's invalid to consider periods before 1975. In the USA, private gold ownership was illegal before 1975. Before 1913, the gold/silver ratio was set by law. State bureaucrats set the gold/silver ratio artificially low, compared to the fair free market price. This enabled seignorage profit for the State, when silver dimes/quarters/dollars were minted.

If you consider the gold/silver ratio, there is no gold bubble. The gold/silver ratio is near the median value since 1975. According to the gold/silver ratio, gold is at worst slightly overpriced.

1 comment:

CarDogg said...

When they print the dollar like it's toilet paper - you can be sure gold and silver are goin' up!

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