U.S. Coin Collecting

Silver – Why So Volatile

A few weeks before the collapse of Lehman Brothers in 2008, it took 51 ounces of silver to buy one ounce of gold. At the height of the market turmoil one month later, it took 84 ounces of silver to buy that same ounce. What makes silver so volatile?

The demand for silver is "elastic" – to put it into economic terms – while the demand for gold is "inelastic".

When demand is elastic, it means that people's preferences are changeable. An inelastic demand means that the item will be acquired regardless of its cost. As an example, the rising price of petrol and diesel fuel in recent years has hardly reduced the demand for it. Fuel consumption has not dropped as its price has risen. People are generally not price-sensitive, at least at present prices, though the demand for fuel may become more elastic at higher prices.

When problems of national currencies increase the demand for gold, it is in fact an increase in the demand for precious-metal-money. Silver of course meets this requirement, as it is a precious metal, and like gold, it too is money. Functionally, silver is a good substitute for gold. Both are tangible assets, and both are money that does not have counterparty risk.

Thus, any increase in the demand for precious-metal-money impacts both gold and silver. However, this increase in demand has a bigger impact on silver because of its elastic demand.

Demand is impossible to measure, but we can see the changes in respective demand for the precious metals by movements in the gold/silver ratio. Movements up and down in this ratio clearly show the ebb and flow of demand between gold and silver.

When people move out of national currencies and into precious-metal-money, money moves into both gold and silver, and the gold/silver ratio falls. Eventually, this flow reverses if people's confidence in national currencies returns. It does so when the monetary problems that caused them to flee the currency in the first place (for example, rising inflation, bank crises, or other problems) are solved. The impact on silver is greater than the impact on gold because the demand for silver is more elastic than the demand for gold, so the ratio rises.

While I am very bullish on the long-term prospects for gold, I am even more bullish on silver. Historically, the ratio of these two precious metals is about 16-to-1. Therefore, as both gold andsilver climb higher in this current bull market as a safe haven from national currency problems, I expect silver to climb even faster than gold, with the result that the gold/silver ratio eventually approaches 16-to-1.

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