In other words, this fall in the gold/silver ratio is possibly different than all the others that occurred in the 1990s and in the last decade. The major difference is that in all the previous declines in the GSR since the 1980 silver collapse there was ample commercial bar silver available to satisfy demand. There is some legitimate question as to whether there is enough supply this time. Therefore, as we move into 2011 we must do so under a Gold/Silver Ratio Breakdown Watch.

In general, when the GSR is trending lower, that is a more bullish than bearish signal by itself. This is the first time, however, since the late 1970s that the fall in the GSR is in connection with either a perceived (at minimum) or an actual (very likely) condition of investor demand being greater than the existing supply of commercial silver bars to satisfy that exploding demand.

Dramatic drops in the GSR such as this one are not unprecedented, but they are quite rare in recent history. The last equivalent plunge in the GSR to rival this one occurred in the 1998 hype surrounding Warren Buffet’s purchase of silver then.

If we weren’t so convinced that the GSR could actually break below the lows of the last two decades, if the news and the rumors we review daily were not so compelling, we have reached the area where in the past we might have said this is a good time to “trade” silver for gold. However, we do indeed believe that lower readings for the GSR are possible and we are on record as calling for a GSR with a “3” in front of it sometime in 2011. As we said before in these pages, we would not be surprised if we see a GSR of 35 by next Christmas and possibly much sooner than then.

(If any of the images are too small click on them for a larger version.)

HOUSTON -- The gold/silver ratio (GSR) tickled a 45 handle on Wednesday, at one point trading down to 45.69. The GSR closed Wednesday and Thursday at 46.18, the lowest daily close since December 11, 2006 when this important ratio closed at 45.26 after an intra-day dip to 44.73. The 20-year chart just below is in weekly terms so the intra-day lows do not show, but it does highlight that the GSR is flirting with historic, two-decade lows. Indeed we have reached the point in the 20-year charts that has proven to be overwhelming “support” since 1998.

(Ed note: A breakdown of the GSR would indicate strong outperformance of silver to gold. A breakdown of the GSR is more like a breakout than a breakdown in other words.)

If demand for silver continues to ramp higher, then there could be a true supply squeeze in the large, average 1,000 ounce commercial bars. Oddly, we have yet to see an increase in premiums for the large 1,000 – ounce commercial size bars locally on the street, so at least as of the last week of 2010 the reportedly “tight supplies” of commercial bar silver have not yet been tight enough to “call in” silver from the public, at least not aggressively.

There is a debate among traders as to whether premiums for the large bars outside the commercial system will rise ahead of or coincident with a supply squeeze. Having been in the bullion business in the past and having talked to other bullion merchants about this issue, we here at Got Gold Report are firmly in the camp that believes that we will see a strong jump higher in premiums for the “big bars” if a commercial supply squeeze gets underway. If for no other reason than the large bars are the most efficient raw material that refiners can use to produce new LBMA or COMEX approved commercial sized bars.

Once outside the bullion bank, futures warehouse or LBMA system, all silver bars must undergo either a re-assay process or they have to be re-refined under the strict guidelines of the commercial silver markets before they can be used for commercial trading. But what if the demand outstrips the ability of refiners to process the small mountains of scrap and privately held silver bars that higher prices will certainly produce?

The spot price of silver is “set” in the commercial bar markets, but during a commercial bar supply shortage, we think all silver products will likely see an increase in premiums. Very high demand and supply shortage in an efficient market eventually reaches even the lowest rungs of the supply ladder – we think, but we won’t rule out the possibility of a shortage of commercial supply alongside a glut of popular small sized silver selling at discounts to spot. Interestingly, that would be the exact opposite of what occurred during the 2008 panic when the spot price fell to absurdly low levels compared to popular small sized silver bars, rounds and coins.

This shorter-term chart shows the dramatic decline of the gold/silver ratio since August which corresponds clearly with the spectacular rise in the price of silver.

It has been our contention for quite some time (for years) that the gold/silver ratio was artificially high during the 1990s. A product of investor disdain for silver together with a very long period of government dishoarding of overly large stockpiles of the metal, which created an appearance of over-supply.

In fact during the 1990s we began a long period where the amount of new silver produced by all sources was less than the amount of silver being consumed each year by industry and all other sources of demand. In other words the world had a new silver supply deficit – the amount of physical silver in the world was declining, but the dishoarded silver made up the difference.

Today the government dishoarding has ended, there is a great deal less silver metal available in the world and investor demand for silver is exploding. That is, of course, a very bullish recipe.

Have we begun a sure-enough supply squeeze for the large commercial bars of silver, or is this the dress rehearsal for it? We cannot know in advance, but so far the signs are not pointing to silver abundance. To the contrary, the largest commercial traders are “getting smaller” in silver hedges and net short positioning even as the price has been rising (backwards from normal). Rumors and rumors of rumors of supply constraints are a daily thing.

If we are beginning a supply squeeze, then the GSR won’t be stopping its fall with a “4” handle. In all likelihood, it will continue to a much lower level, perhaps in line with its long-term historic relationship to gold somewhere between 15 and 20 ounces of silver to “buy” an ounce of gold.

Likely that won’t happen overnight, but it might happen a lot sooner than many might think possible.

When we first started using the graph below (or one similar to it) there were more than a few disbelievers.

Now that silver has actually reached the upper limit of the trends suggested in that no-log scale graph, let’s take a look at the same graph in log scale, which shows a more demanding challenge in the linear trends. (A no-log scale gives equal weight to each $1 nominal. A log-scale graph gives equal weight to price changes in percentage terms.)





Now, in December of 2010, gold has already eclipsed its former nominal high of $850 set in 1980 by as much as 68%. Silver would have to trade to $84 in order to “match” gold’s performance so far. An $84 silver price is therefore not impossible. Silver hasn’t even been able to reach its former pinnacle, also set in 1980 near $50, much less travel above it. The 2008 panic probably has quite a bit to do with that, but silver has an amazing capability to make disbelievers out of everyone with its price movement and volatility. We cannot be surprised if silver shows us all a world class example of “catch up” with its yellow cousin in other words.

Demand for commercial sized average 1,000 ounce silver bars has ramped up to the point where there is a legitimate question of availability, as there are many multiples of the amount of bar silver sold short in paper instruments and contracts at the same time exploding demand for physical silver is raging.

Once again, we cannot know if this event in December of 2010 is the beginning of the “Big One” or merely a warm-up, a rehearsal, a warning shot … and that is why we Vultures use trading stops for our short-term trading positions instead of trying to guess where a top might form. If this proves to be the Big One, we sure do want to be on board for it. But if this is merely a giant tease by the Trading Gods, then our stops will get us out and to the sidelines with our short-term trades and we can then calmly decide where and when we want to re-deploy.

We realize that by now Vultures (Got Gold Report subscribers) already know this, but out of an abundance of caution when we refer to our trading stops we are talking about our short-term trading positions only, not our longer-term physical metal holdings.

One thing we do know absolutely is that silver has finally cast off the moniker of “Gold’s Red Headed Stepchild.” Translation: The global attitude toward silver is quickly, finally morphing from “who cares” or disdain to “want some” and respect. As 2010 comes to a close, it does so with silver in a historic redefinition of upper resistance.

It’s about time, but there is only so much silver to go around, so the ride this time might be thrilling.

Meanwhile, as always, MIND YOUR STOPS.

The CFTC commitments of traders report is once again delayed until Monday. No GGR this weekend, but we will be updating our linked charts by Sunday at 18:00 as usual. Vultures be sure to check those important charts for changes in our trading stops to begin 2011.

Thank you for honoring us with your time and your business. Happy New Year everyone!





