Extreme ratios indicate readjustments in gold and silver prices

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Throwing the box on the road is the new national pastime. Whenever government bills come due, Treasury Department officials find creative ways to pay them with money they don’t have.

The debt-to-GDP ratio is a measure of how financially too big the United States has become. For most of the country’s history, with the exception of temporary wartime turmoil, general government net debt has tended to represent less than 50% of the economy.

As recently as the early 1970s, debt as a percentage of GDP was less than 25%. In the early 1980s, it rose to over 30% and the fiscal hawks got worried. In the 1990s, it shot up to over 40% and worry began to turn into alarm.

Last year, the ratio of US government debt to GDP exceeded 100% (1: 1). In other words, taxpayers owe more than the value of everything they produce.

This is the death knell for most countries. The International Monetary Fund issues terrible warnings to third world countries as soon as they cross the threshold of 70% of GDP.

The United States is different, apparently, thanks to the status given to the Federal Reserve note as a world reserve currency. Until 1971, this status was supported by a promise to redeem in gold dollars held by foreign governments.

Gold has also been used to restrict spending and borrowing at the federal level.

But since President Richard Nixon canceled the repayment of the gold, politicians have been given the green light to take on unlimited debt.

If Joe Biden’s White House passes all of its spending proposals, an additional $ 9 trillion will be added to the national debt. Unless there is a corresponding miraculous increase in GDP, the debt ratio can be expected to continue to move in the wrong direction.

It’s unclear how long officials in Washington can keep kicking the road before throwing it off a cliff. These are, after all, an unprecedented time when the Federal Reserve’s “lender of last resort” has virtually unlimited powers.

But the central bank cannot bail out Uncle Sam perpetually without unintended consequences. Fearing a debt crisis can mean triggering a currency crisis.

Gold is about to outperform the stock market

During major financial crises in history, gold significantly outperformed paper assets.

For example, the deflationary Great Depression and inflation of the late 1970s saw the price of gold rise to a 1: 1 ratio against the Dow Jones Industrial Average.

The Dow is currently trading at over 35,000, about 20 times the price of gold.

If the Dow: Gold ratio returns to 1: 1, either stocks should collapse, gold should jump into a super peak, or a combination of the two.

Given the enormous inflationary pressures currently in the economy, the late 1970s may be the best model for what to expect in the future.

This would mean higher prices combined with a weak economy (stagflation).

And given that our debt load is now more than four times greater as a proportion of the economy than it was in the 1970s, investors should be prepared for the potential of a much deeper financial crisis.

In the event that this happens in the form of a collapse in the value of the US dollar, gold will obviously serve as a top-notch safe haven.

Silver is about to surpass gold

But silver could perform even better as an inflation hedge. It did so in the late 1970s, until its January 1980 super peak of nearly $ 50 / oz.

Some reject this move as being artificially induced by the Hunt brothers, who tried to corner the silver market. However, they shouldn’t rule out the potential for yet another mad rush for scarce silver reserves, fueled by a broad and deep global demand rather than a handful of speculators in the futures markets.

This time around, it could be Tesla or a solar panel maker, for example, trying to “corner” the silver market by building up strategic stocks.

Or it could be a large number of individual investors mobilized in Internet forums to collectively “corner” the physical money market. Crowdsourcing campaigns by money enthusiasts are already underway in an attempt to force the hand of paper futures traders engaging in naked short selling that artificially suppresses spot prices.

For now, silver remains relatively cheap not only compared to most financial assets, but also compared to other durable assets. In March 2020, silver became historically cheap compared to gold – at one point, the gold: silver price ratio hit a record high of 130: 1.

The gold / silver ratio is currently around 76: 1. There is still a lot more room to shrink in favor of silver during a bull market in precious metals.

At the peak of 1980, the ratio was close to 16: 1, which is often referred to as the “classic ratio” observed since ancient times.

Meanwhile, the current mining ratio is only around 7: 1, according to First Majestic Silver CEO Keith Neumeyer. That is, mines around the world produce 7 ounces of silver for every ounce of gold they put on the market.

With so many ratios seemingly out of whack, investors would be wise to reconsider the ratio of durable assets to paper assets in their portfolios. And those who already have a conservative gold bullion allocation should make sure that they also have an adequate ratio of silver holdings.


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