A LOT OF TALK on the web right now says silver is significantly undervalued versus gold.

Many of these pundits and talking heads like to point to the historical relationship between gold and silver prices, sometimes known as the “ratio”. People even comment as to this connection as far back as thousands of years ago. Let’s take a quick look at this.

Silver, thousands of years ago, was originally thought of greater value than gold, both because it was relatively scarce in great civilizations such as the Egyptians, and because it was easier to work into useful materials. Both silver and gold have been used abundantly for ornamentation and as a thing of beauty in homes, temples and palaces. Then of course as jewelry their beauty was very much esteemed.

However, once gold was found in increasing abundance and man’s metallurgical skills improved, gold soon took over as the leader and the metal given greater value. Though silver would not lose completely that position, it would fall into the number two spot. One of the main reasons is gold’s ability to be beaten and stretched to great lengths with out and still maintain it beauty. But the most important of its properties was that it did not tarnish. In a thing of art and beauty this is an important factor and one that still to this day maintains Gold’s lead over silver for prominence in the jewelry industry.

Getting back to the ratio, as time went by silver would continue to be found in greater abundance than gold. So the differential moved to a 10 to 1 relationship in medieval Europe, and was then fixed at 15.5 in England by Isaac Newton when he was Master of the Mint in 1717. That’s almost exactly the ratio of unearthed silver to gold in the ground worldwide. As recently as the early twentieth century we had gold and silver at a 20 to 1 ratio when silver was coined as One Dollar and gold was Twenty Dollars in the USA.

Now we are looking at the current ratio 53.15 as of this writing. It sounds high looking at historical standards. What about recent history?

Some people will point to the 1980 low of 14 to 1. But at that time the silver market was said to have been cornered by the Hunt brothers, making that level an artificial low as silver prices jumped. In 1991 we saw the high of 100 as gold hit $412 per ounce and silver remained around the $4 level. In the last ten years we have been as high as 80 and as low as 31.60.

So is this a good barometer to the direction of the price of silver or gold? I don’t believe so. But the ratio between gold and silver prices is an exciting spread to trade at times, even though the two metals move in the same direction almost each and every trading day.

Both metals are precious, and silver is often found with gold in the ground. Yet they are not blood related, and it’s the differences which might explain the widening or narrowing of the ration in prices.

Silver is produced in abundance as a byproduct of many other processes as well. Zinc and copper mining are among some of the principal producers. According toThomson Reuters GFMS in a report prepared for the Silver Institute, nearly two thirds of the world’s annual production of silver is as a by-product.

In the same report it is stated that in recent years silver production has increased by 25% while gold becomes ever rarer at a slower growth rate of only 6% over a ten year period. Even with the high price of gold it can’t seem to keep pace with silver. So supply and demand would have us believe that silver is increasingly more available.

Then what are these talking heads saying when they believe silver has a better opportunity for price growth than gold? Where do they come up with their belief?

Silver for sure is always in demand and though photography and x-ray film once the major consumers of the white metal are quickly disappearing new and exciting applications have come online. Photovoltaic, a major consumer, came into the fold a few years back. It continues to grow. Though, it is off significantly from its 2011 high, which still did not reach the annual consumption of silver by the photographic industry in the early part of this century.

Thomson Reuters GFMS states that world industrial demand will have dropped 8% in 2012. According to the USGS (US Geological Survey) 2011 Minerals Yearbooktotal US industrial consumption of silver was down 5% from 2010. So it is the investment market that has truly come in to fill the gap in silver.

In the same report we read that Coin & Medal demand was up 19% in 2011 over 2010 globally. The silver ETPs (exchange traded products) has grown to be holding currently around 623 million ounces which is 83% of a year’s annual production. And this January the US Mint had record sales of their silver eagle bullion coins of 7.42 million ounces as the public fears of currency devaluation weighs heavily on their minds.

Still even with this information can we be certain that silver has more upside? This is a very difficult look into the future. I believe the precious metals class will continue to perform for the foreseeable future, at least another five years while the global economy keeps languishing. The global credit problems are not over. Spain and Italy remain in crisis to mention a few and this illness will cause the doctors to keep prescribing easing, or increasing cash liquidity (printing more money).

But what of the fundamentals cost of production? The Silver Institute reports a cash cost of $7.25 per ounce for 2011. Using this as a baseline I believe most people would believe silver to be overvalued. But this number does not reflect the actual final cost to market of the metal in a form that is ready for consumption. It lacks all the detail necessary to make an informed decision. This is why it is not trading anywhere near these numbers.

In a very well thought out article, Silver Deceptions: Large Surpluses & Low Production Cost, Steve St. Angelo at SilverSeek argues that the actual cost of production for mining silver is much higher. Using his method of calculation, the cost of production of silver for 2011 should be $28.02 and for gold should be $1359.80. This would mean that silver at a little over a 10% premium at these market levels while gold is at over a 20% premium to today’s price.

I guess there you have it. Before considering the industrial or monetary use of silver in future, investors looking for more upside potential in silver than gold might start with that 10% differential in cost of production.

Miguel Perez-Santalla

BullionVault

Miguel Perez-Santalla is vice president of business development for BullionVault, the physical gold and silver exchange founded a decade ago and now the world’s #1 provider of physical bullion ownership online. A fierce advocate for retail investors, and a regular speaker at industry and media events, Miguel has over 30 years’ experience in the precious metals business, previously working at the United States’ top coin dealerships, as well as international refining group Heraeus.

(c) BullionVault 2013

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.