One way precious metals investors try to maximize their results is buy predicting which of gold or silver (and some people also consider platinum and/or palladium) will outperform the other going forward. A correct judgment has often led to dramatic results.
For instance, on November 20, 2008, the prices of gold and silver closed in US markets at $756.50 and $9.43, respectively. Then, the price of gold was more than 80 times that of silver, meaning that the gold/silver ratio was more than 80. Ever since then, I have been forecasting that silver would outperform gold, though both would rise.
That is exactly what has happened in the 29 months since. Today, gold and silver closed in the US COMEX markets at $1,494.50 and $43.92, respectively. The gold/silver ratio has dropped to just above 34. Since November 20, 2008, the price of gold has increased 97.6% while silver has soared 365.7%
At some point, the gold/silver ratio will tend to reach equilibrium, absent market manipulation. It is highly likely that, before any equilibrium is reached, the ratio will overshoot its long term equilibrium.
For the past few years, I have projected a long-term equilibrium ration in the range of 35 to 40. Still, even though today’s ratio is below the lower end of the range, I would not be surprised to see the ratio fall as low as 30—even if my forecast of a long-term ratio between 35 and 40 is accurate.
My long-term gold/silver ratio is fuzzier than several of my other predictions. While I don’t think the long term ratio will exceed 40, it is quite possible that it could be lower than 35. It may even be lower than 30.
I am starting to receive numerous inquiries asking whether now would be a prudent time to consider swapping physical silver into gold, seeking to make extra profit if the price of gold outperforms silver from now into the future.
Thus far, my answer is NO.
There are three reasons for this conclusion.
First, as I stated, I consider it possible that the long term ratio may be lower than today. If so, a swap would underperform going forward.
Second, every time you do a swap, the dealer will want to make at least a tiny margin for doing the transaction. That means that the merchandise you receive in a swap, at that instant, will be worth less than the merchandise you just traded away. Therefore, you don’t want to do any swap where the likely improvement in your position will only be a few percentage points. Don’t do a swap unless the swing in the ratio reasonably looks to be at least 20%. (By the way, be careful of dealers who make a swap recommendation as they may simply be trying to drum up business rather than offering you their best judgment.)
Third, any swap from one metal to a different metal makes that swap a taxable sale for American taxpayers. With gold at record high levels and silver close to its all-time high (ignoring inflation), virtually everyone contemplating a swap would end up having to report a taxable profit on the swap. Long-term capital gains rates on sales of precious metals and rare coins fall under the “collectibles” definition, which means that they do not qualify for the 15% tax rate. Instead, the tax rate on profits from swapping gold or silver would at 28% or the top marginal tax rate for the specific taxpayer, whichever is lower.
To take a hypothetical example (actually a customer asked me this very scenario yesterday), if you purchased some US 90% silver coin several years ago for $1,960 and we now offer to buy it or take it in trade at $14,960, and you happen to be in the 25% tax bracket, that means that the IRS would want 25% of the $13,000 “profit,” or $3,250, on the silver you traded away. If you live where you also have to pay state or local income taxes, that would make the total tax burden even higher. What that would mean is that the gold you might receive in a swap would have to outperform silver by at least 30% simply to break even with what would have happened if you had never swapped your silver! Right now, I do not expect that gold/silver ratio to rise to at least 44.2, so I would recommend against going this swap.
My answer to the question about silver into gold swaps could change as new information develops, but I think you can see why I’m not ready to recommend them right now.
Anyhow, for the short-term, silver still looks to me like it will outperform gold.
Patrick A. Heller owns Liberty Coin Service in Lansing, Michigan and writes “Liberty’s Outlook,” a monthly newsletter covering rare coins and precious metals. Past issues can be found online at http://www.libertycoinservice.com/ Pat Heller is also the gold market commentator for Numismatic News. Past columns online at http://numismaster.com/ under “News & Articles”. His bimonthly columns on collectibles can also be read at http://www.lansingbusinessmonthly.com under “Articles” and “Department Columns.”His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.