This question is one of the most frequently asked questions not only by those who recently became precious metals investors, but also by seasoned investors. My answer to this question is this: 25% gold and 75% silver.
This short article is not an attempt to provide three points that make the case for my answer. A disclaimer is in order: I am not a financial adviser, and the views expressed here are merely my own personal thoughts, preferences, and strategies.
My justification is threefold; 1) potential for growth, 2) the silver/gold ratio, and 3) utility.
Return on Investment: A Hypothetical Scenario
The gold price topped out at approximately $1,900.00 per oz in August 2011. The spot price of gold today is around $1,460.00 per oz. (And here comes the hypothetical variable.) If gold returns to its previous high from the price levels today, the dollar return would be around 25%.
At around the same time, silver reached almost $50.00 per oz in April 2011, seemingly pulling gold higher. If we return to the previous price levels (which is now a technical resistance before reaching new all-time high), the return from the current price levels of $17.00 per oz, the dollar return is almost 200%.
So, which of the two metal should investors hold a higher ratio in a typical precious metals’ portfolio? One that, if previous highs are achieved, would give a 25% growth, or one that may yield almost 200%? Seems to me, at least, that the answer is obvious.
The Gold/Silver Ratio: One for Eighty-five
The current gold/silver price ratio is over 85/1. That is, 1 ounce of gold can purchase 85 ounces of silver. The historical average is around 20/1 (conditional on how far back you go). If you take the last 30 years or so, the gold-silver ratio is around 60/1.
Moreover, the naturally occurring ratio in the ground is 1/11 (11 ounces of silver for each ounce of gold). Once would expect these realities would reflect in the price, notwithstanding the costs to mine each metal. All indications are that silver is grossly undervalued relative to gold.
At a ratio of 20 to 1 (the historic average), silver should be around $300 per ounce. While that is a little ambitious, even a ratio of 50 to 1 would mean silver should be priced much higher relative to gold.
In any case, I think the advice of Mike Maloney is spot on here, explaining that given the undervalued price of silver relative to gold, an investor’s portfolio should loosely reflect the gold/silver ratio. That is, 75% silver, and 25% gold. This ensures holding a higher ratio of the metal with the most potential for higher return on investment.
Utility: May I have a Kilogram of Potatoes Please?
Utility is a very important aspect investors should consider, especially those who foresee a scenario in which there is a major global financial crisis from which South Africa will not be immune.(I am not an alarmist, and this is strictly a hypothetical scenario. However, it is important for me to share that most precious metal investors do indeed buy silver and gold for such situations; it is one of the chief rationales for purchase.) That is, if a situation should ever arise in which precious metal holders may need to use their pounces to trade or survive, having a higher ratio of ‘change’ will be convenient. By change, I mean smaller denomination of money. For example, if someone has a 1 oz gold coin, buying a kilogram of potatoes or a tank of petrol will be problematic. However, having 1 oz silver coins will make the transaction possible.
One could argue that in such cases, a 1/10 oz of gold has excellent utility. However, today, a tenth of an ounce of gold represents over seven ounces of silver. Therefore, it seems prudent to own a higher ratio of precious metals in smaller denomination, as it will serve investors well in times of socio-economic upheaval. This is especially the case if the government further regulates gold purchases, making gold either more expensive or scarcer.
In conclusion, then, I think that a ratio of 25% gold and 75% silver is an ideal ratio, given the current price ratio between silver and gold, silver’s potential to outperform gold in the long run, and the superior utility of silver in every day trade should we face major local or global financial crisis, whether it is hyperinflation, recession, or depression.