Silver and Gold Glitter

February 1, 1999


Why did Warren Buffett buy 3,800 tons of silver? Perhaps one of the longest-running downtrends in investing has reversed course.

SILVER HAS BEEN GLITTERING ever downward: 1992's price of $4.73 per ounce, restated in 1998 dollars, was the lowest in six centuries (see chart). By contrast, the long-run real price of gold has been remarkably stable over most of that period. (Right now gold seems low by historic standards—at around $300, only about half of its average level for the last two centuries)

Arguably, silver's slide has something to do with its gradual demonetization—the end of its role as a monetary metal. In the Anglo- American world, the silver standard dates from around A.D. 800 and significantly predates that of gold. Britain's pound sterling originally meant a pound of silver. In the U.S., William Jennings Bryan's 1896 insurgent presidential candidacy was aimed at restoring silver's monetary role and relieving the deflationary impact of the gold standard—the "cross of gold." Possible implication: Now that gold no longer plays a formal role in the monetary system, it may slide, too.

But silver has rebounded from the early 1990s nadir. And some investment professionals think its slide may be over, at least for a while. Leigh Goehring, manager of the Prudential Natural Resources Fund, notes that, to a greater degree than gold, silver has industrial uses. It is also consumed in jewelry and silverware, and hoarded in countries like India. All told, annual demand amounts to 800 million ounces worldwide. Recycling plus new production supplies perhaps 600 million ounces a year. Western silver hoards built up during the 1970s inflationary spike must be close to complete liquidation. After that, there could be a real silver squeeze. Says Goehring: "I don't know how much lower silver can go."

Warren Buffett apparently agrees. Berkshire Hathaway last year bought 111 million ounces of the metal—3,800 tons. (A ton is 29,167 troy ounces.)

At one time, many market watchers believed that gold and silver tended to move in tandem—that the ratio of gold prices to silver prices was fairly fixed. After the gyrations of the last 30 years, this belief is no longer fashionable.

But our chart reveals that, further back, the gold/silver ratio theory did indeed have a rationale (sort of). For 500 years it hovered in the upper teens. It broke down in the late 19th century, a time of increased silver supply and demonetization, and came apart completely in the monetary turbulence of the 20th century.

The inflationary climax of 1980 has pushed the gold/silver ratio down towards its historic level. "The possible return of inflation is a huge kicker for silver," says Goehring. "It's a no-lose situation."



Measured by the men's suit standard, gold is very cheap today.

"WITH AN OUNCE OF GOLD a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson, in the Depression of the 1930s," according to one of the sources for our chart. That remained true in the 1980s, but it isn't true in the late 1990s. The suit standard now implies a gold price of perhaps $1,000 per ounce. A really good man's suit today can easily cost 4 ounces of gold—say, $1,250 at gold's mid-April high for the year to date. And that's without a vest, once standard.

Which is particularly interesting because the real gold price has been astoundingly stable since Shakespeare (born 1564). Even in the troubled 20th century, with inflation in the West on a scale unprecedented during the last 600 years, gold's wild oscillations averaged at $612, very close to its $639 average for the tranquil 19th century. And comfortably within its historic range.

Interesting point: Gold will have to rise by about $300 just to get back to the $627 average of the last two centuries.

Arguably, some of those 20th-century oscillations were due to the 1934-71 U.S. government fixing of the nominal gold price (shown on our chart as a real price decline, because inflation ate away its purchasing power) and the subsequent rebound.

Plus the gold price does seem to have staggered temporarily in response to supply shocks—for example, the Californian and Australian discoveries in the middle of the 19th century, the Yukon and South African discoveries at its close.

A supply shock is the favored explanation for our chart's most striking feature: the abrupt and permanent downward shift of the gold price in the early 16th century. That's when the gold stocks of the Aztecs and Incas were introduced to world markets, courtesy of the Spanish conquistadores, and the Western Hemisphere's gold mines began to make their presence felt.

A pleasingly convenient symbol: The price of gold reached its historic peak ($2,400 in 1998 terms) in 1492, when Columbus sailed the ocean, etc., etc.

Of course, past performance is no guarantee of future success. But compared with its post-Shakespeare norm, gold is unquestionably rather low.

You could argue that recent technological improvements and demonetization have caused a (permanent?) supply shock.

Or you could take the situation at face value and agree with portfolio manager Caesar Bryan, whose Rye, N.Y. -based Gabelli Gold Fund is the best-performing gold fund this year. "This chart says cheap to me," he concludes.


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