Friday, August 16, 2013

Relative Value -- Part One

Over the past week or so I have been busy, but I have been thinking about a few subjects that could mostly be lumped together as a topic I call "Relative Value".  After some brief comments on our bearings (very valuable), I will examine relative values of the precious metals with each other.  I will look at other items of "relative value" in the near future, so this is the start of a short series of related articles.

Certainly for me, rolling bearings that we sell in Peru are of great value, it is our principal way of adding value to our world, and hence making money for doing so.  We add value to Peru's automotive spare parts market, our customer pay us for the pieces rather than paying our competitors.

Just today (Saturday) our Collections Director Raul told me that our sales of Chinese bearings and hub & bearing assemblies are still strong.  And we have Korean bearings that will arrive later in August that will help sales a lot as well, including our best selling piece (the 6007-RS for Daewoo Tico).

So for us, objects made of  "52100 steel" (bearing steel) are precious, metal products of high relative value to us..., practically precious!  But, in our case, steel bearings are actually producing an income (precious metals just sit there), a stream of wealth, and that surely has value...  Not the same kind of value as gold, not even really "relative to gold", our bearings (and bearing business) represent more a different class of value.

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And of course, physical precious metals have a very high relative value compared to almost anything else.  The below picture is in honor of two people I do not even know, but it is a celebration (a 50th Anniversary!).

"Little Gold"


The photo shows US 1/4 oz and 1/10 oz Gold Eagles on the left, a 1/4 oz Krugerrand in the center and 1/4 oz and 1/10 oz Canadian Maples on the right.  My picture is not perfect, but you may be able to notice color differences between some of the coins (the angle of my photo influence the colors as well).  The Krugerrand in the middle shows a slightly rose color because the K-rand is 91.67% gold, the balance is copper, the copper making it slightly more pinkish than the others.  The American coins are also 91.67% gold, but the coins are alloyed with 3% silver (balance is copper), so the coins are not as reddish as the K-rand.  The Canadian gold on the right is all 99.9% percent gold, and is also polished up more finely than the American, and so has a brighter more clearly "gold-shine", although that is not obvious in the picture.

For me, "Little Gold" (small gold coins) have a value that is beyond their actual bullion value of, say, 1/10 oz in their smaller size.  The smaller sizes, of course, sell at a higher premium as the costs of minting them are relatively higher.  Smaller sizes have real value to me, they would be good for smaller transactions if it ever comes down to having to part with my gold...  Why would smaller gold pieces (1/10 oz) have value to me?  Because their value is approximately the "geometric mean" between the 1 oz Silver Eagle and the 1 oz Gold Eagle, meaning that the value of a 1/10 oz gold coin is "halfway between" the other two...:


(ln($23.25) equals about 3.1, ln($138) equals about 4.9 and ln($1375) equals about 7.2)

And the concept of "Relative Value" here?  Since I already have 1 oz coins, the relative value, to me, of 4 pieces of 1/4 oz coins is a little higher!  Much more flexible in making purchases (should it come to that) or for gifts (hah!  Don't hold your breaths...).

Would it ever become hard to sell gold?  No, I think not.  "There is always someone around who will accept your gold."

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A topic that recently  has gotten even more attention than it normally does is the relative value of gold vs. silver.  This is most often looked at by the Gold-to-Silver Ratio (Au:Ag or "GSR").  The GSR is used by many traders of precious metals to try to identify which is overvalued (or undervalued) among the two.

Through history, the GSR has been relatively stable (more so than in the charts below).  Typically the GSR has mostly been in the range of 12:1 or 16:1.  This probably reflects the relative mine-able abundance of gold and silver in the earth's crust.  I have read, however, that in ancient history (Egypt) that the ratio was 1:1 (silver had the same price as gold!).

Here is a chart showing this ratio over recent months (as always, *click* on any image for a better view).  Please also note that all of these charts are for "paper gold", I would bet that once you (well, maybe not YOU, but me neither...) are at the level of trading for say, 100 metric tones of gold, that you would pay far, far more...  But these charts do give a fair representation of the relative values of the precious metals at present.


The chart has been very spiky over the last months, most notably during the time of the gold & silver price crashes in April and in June (and of course now in August).  I would attribute the decline in the GSR in August (so far) to the recent outperformance of the price of silver.  Gold has gone up to be sure, but silver has gone up faster.

This next chart shows the same GSR, but for almost three years:


There are a LOT of interesting things to note in the chart just above.  First would be the remarkable nine month or so plunge in the GSR from late 2010 to May, 2011.  This was when the price of silver shot to almost $50.  Of interest to me is that during April of 2011 was when I did my only "trade" of precious metals, I turned in a bunch of silver for a much smaller amount of gold.  On the day I traded it in, the GSR was about 36:1, so I was lucky...

Silver is notorious for being volatile, for that it is sometimes called "The Devil's Metal"...

That same chart shows the GSR 200-week moving average to be pretty steady at around 58:1 or so over the past three years.  Does this 58:1 ratio represent a fair relative value between gold and silver?  My best guess is that yes, for the short-term it may very well (please note that my prediction record is poor, so I "guess" now...).

But, the more important question is what the future GSR ratio will likely be.  Is gold a better "relative value" than silver?  My "guess" is yes it is.  The line I have trotted out before is that FOFOA is likely to be right in the end, that gold, and only gold, will have its big revaluation because of a likely default in delivery among the very top holders of gold.  Similarly, the world's central banks hold gold alone of the precious metals.

I have also recently come to believe that silver has become mostly "demonetized" (demonized?).  By this I mean that silver is less looked at "as money" compared to the past.  Those of us old enough to remember US coinage from 1964 and earlier can remember when silver dimes and silver quarters were what we got as change back from a dollar!  This almost seems absurd now, even though the US Constitution mandated that our coinage be gold and silver (the bimetallic standard was arguably a mistake, but that is for another time...).  "They" were successful and did it: demonetized silver.  So even though silver is scarce (above ground stock of silver is less than the 15:1 or so historical average) AND that silver is the commodity that is used in more applications than any other (except oil), my bet is more on Au than Ag...

One other thing about silver being less than ideal in times of financial distress.  One of FOFOA's most serious followers lived through a hyperinflation.  He reports that at no time was silver a commonly bartered item.  People wanted cash!  But they wanted the cash fast, and then wanted to spend it fast!  I need to check back, but I believe that gold was often taken in barter, as I mentioned above, there is always someone around who will take your gold...  I will take gold for almost any payment...  ;)

Also, from a limited experience of my own with hyperinflation (as a visitor to Peru during a hyperinflation of theirs), in Peru in those days, I never saw silver being exchanged as a payment mechanism, neither by a buyer offering to pay in silver nor a seller asking for silver.  Even with a hyperinflating currency, Peruvians wanted CASH!

And so, at the risk of antagonizing fans of silver, I conclude that gold is a better relative value to me, in my circumstances and at this time.  Of course, I could be wrong, so I also own some silver.  The silver I now hold is really for a TEOTWAWKI.

And what would I "guess" will be a likely GSR ratio in the future?  200:1!

***

Since this article is about relative value of precious metals, I present two more charts showing more relative values.  This first one is Gold to Platinum (Au:Pt) from late 2010 through 2013 to date.  Through time, platinum has typically had a premium averaging around, say, 20% to gold.  Will that continue into the future?  Platinum is some 30 times rarer than gold, and has many more industrial uses...  Again, my "guess" is no...


Gold has been trending back down to its "normal" (historically normal) relative value of around 0.80 - 0.85 to the price of Pt.  Will Au: Pt ever go to, say, 20:1 (as more-or-less predicted by FOFOA)?  That is a harder for for me, but my guess is that gold will indeed outrun platinum by a considerable margin.  Why?  Pt shares two important characteristics with silver: it is not money (never really was monetized in the first place) and it is used in industry.  Could platinum have a huge reset?  Hey, anything is possible, especially considering how rare Pt is (and where it comes from: risky places like South Africa and Russia).

And palladium (platinum's little sister)?  Palladium has had an almost unbelievable volatile ride since just before the financial crash in 2008 (and so will not show in the chart below).  Pd rose to over $1000 per oz when Ford loaded up on it thinking that was to be their catalyst of choice (for their catalytic converters to reduce air pollution).  That is reported to have cost Ford some $2 billion...  This chart is again a weekly chart for the period of late 2010 - 2013.  Note how all three charts look a different!  I wonder how much of these different price movements represent "fundamentals" (mine supply, new applications) vs. traders' actions...


Palladium has had a very good run over the past several months, that is why the Au:Pd ratio has been declining.  Pd is an interesting metal (that I have discussed before), but it is almost all used in industry of one sort or another.  Some Pd is used in white gold, and some more is used in jewelry in China to replace platinum.

While I think that gold once again is the best choice for the longer-term, I can have no objection to diversifying into platinum or even palladium (but I would get gold and silver first, especially gold).

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