All That Glitters Is Gold, Uhm Silver.

On today’s show we’re talking about your frame of reference. The price of silver has gone up 28% in a little over two weeks. But we’ve been saying for a long time that silver is undervalued relative to gold. Two months ago gold was trading at 115 times the price of silver. In historic terms, that’s a nearly record breaking ratio. Either gold was over valued or silver was undervalued. Through much of history the ratio between gold and silver has been hovering in a range between 50 and 70. Sometimes it would go outside that ratio. For example, in the period from April 2010 to May 2011, the ratio dropped from 65 to 30 before rebounding back to 60 a year later. When silver was trading at such a discount, buying more silver seemed like the obvious thing to do.

Markets are truly inefficient. Even markets with high degrees of liquidity and millions of participants can get off balance for a period of time.

If you’ve been listening to this podcast for a while then you’ll know that I’m not a huge fan of the Wall Street Casino.

While the price of silver has nearly doubled since March of this year, that may be an illusion. That’s because your frame of reference is dollars. Frame of reference is extremely important. Some people measure their wealth in terms of dollars. Others may choose to measure their wealth in ounces of silver and gold.

You see, you might be standing still as you’re listening to this podcast. Or you might be seated at your desk. If you’re in your car on the freeway, you might be driving 60 miles an hour. But of course none of those are correct. You’re on the edge of the earth that is spinning at about 460 meters per second or about 1,000 miles an hour. It doesn’t feel like you’re traveling that fast, because of your frame of reference. It turns out that 1,000 miles an hour isn’t quite right either. You see the earth is spinning around the sun at a speed of about 30 km per second or about 67,000 miles an hour. It all depends on your point of reference. Some people choose to keep dollars as the point of reference.

But dollars are constantly in motion. They’re continually declining in value. Dollars are not money, they’re merely currency. In order for something to be considered money it must perform two vital functions. It must serve as a means of exchange and as a store of value. Dollars are a very effective means of exchange, but not a very good store of value.

So far, we’ve been successful in exporting our inflation. When you go to Walmart and buy a pair of shoes that were made in China, or perhaps an electronic gadget, the supplier to Walmart gets paid in US dollars. That supplier has no real use for US dollars so they go to their local bank who exchanges the dollars for Remnimbi. China’s central bank ends up with a surplus of dollars. So they go in search of assets they can buy with US dollars. For years, they’ve been buy US Treasury bills. It’s the perfect solution. The trade deficit with China results in China buying the surplus debt of the US Government. All those extra dollars in circulation get taken out of the economy in the West and end up buying the excess government debt. It’s a system that works perfectly until it doesn’t.

When you put dollars in the bank , you’re  exposed to counter party risk. If the bank goes bust, then you don’t have any money, you merely have a claim on money that is actually the bank’s money that you have put on deposit with the bank.

When you hold the physical metal in your hand. There is no counter party, and therefore there is no counter party risk.

So back to the frame of reference. My analysis is pretty simple: the more money that central banks print, and the more debt that governments take on, the more valuable gold and silver will become. Said another way, : the more money that central banks print, and the more debt that governments take on  the less valuable the currency will be.