Silver is one of the most under appreciated commodities around. Back in 2011, an ounce of gold was worth 32 ounces of silver. Today, that same ounce of gold translates to 74 ounces of the grey metal. Does that mean gold has gotten more valuable or that silver has gotten cheaper?
Since its peak a few years ago, silver prices have dropped nearly 70%. Gold prices have also fallen by an astonishing 35% during the same period, which convinces me that investors got overly pessimistic about silver during the pullback.
So, what should the true price of silver be?
In order to properly value silver, we need the silver-to-gold ratio. Historically, silver shadows the movement of gold prices. When gold drops, silver prices are close behind.
Over the last 40 years, the conversion averages out to 42.8 ounces of silver for one ounce of gold. But the relationship fluctuates and sometimes one of the metals will become significantly undervalued.
When the ratio drifts too far from the historical average, it usually foreshadows a big run. This has happened three times in the last 20 years; in 1995, 2003, and 2011. The respective gains for silver prices were 70%, 200%, and 420%.
If we assume the same gold price and use the 2011 conversion rate, silver should be around $36.60. Right now, the price of silver is hovering around $15.90, with a conversion rate of 74.0.
That being said, how can silver possibly go to $50.00?
Well, despite its apparent cheapness, silver is simply not as abundant a metal as investors seem to think. When you compare the actual deposits of silver and gold in the earth, the natural multiple is 17.0. Ideally, the physical relationship between silver and gold deposits should dictate the price relationship.
In order for silver to hit $50.00, the ratio would have to drop to 23.0, assuming that gold stays at its current price of $1,170.
However, if the stock market bubble finally bursts, investors may flee to gold and silver as a safe haven. Under those circumstances, silver could rise to $50.00 much quicker.
Follow the Smart Money
I’m not the first person to notice this amazing buying opportunity.
In the first quarter of 2015, billionaire investor Ray Dalio loaded up on more shares of Silver Wheaton Corp. (NYSE/SLW). The hedge fund manager now owns 510,000 shares valued at roughly $9.0 million.
If you want to cash in on a huge silver run, but are hesitant to own silver directly, Silver Wheaton may be a wise choice. The company finances smaller mining firms and pays for any silver they find, thus limiting the downside risks associated with managing a mine.
The stock is down almost 34% over the last year because of depressed commodity prices, but Ray Dalio and I both think that will change.
Low interest rates from the Federal Reserve have been propping up the stock market, but a rate hike later this year is virtually guaranteed. And when the market loses support from the Fed, a flight to safety will mean huge gains for silver.
