I had just finished the latest issue of my newsletter when I experienced a "This Just In" event. Gary North's latest Reality Check missive had been sent out and the subject was "Buy Silver or Gold?" This was all rather providential as the main subject of my newsletter was "Gold or Silver?" But whereas I was more bullish on silver than gold for the foreseeable future, Gary North took the opposite view and went with gold as the prime investment of the two. Since the subject was fresh in my mind, now was an opportune time to reply to some of North's arguments. You may find his article here.

First Gary North and I are agreed on several things. The first is that the future is inflationary and not deflationary. I am even more convinced of that with Ben Bernanke now at the helm of the world's most powerful central bank.

Secondly, I agree with him that gold falls in price during a deflation. The only open question is whether it falls at a different rate to other commodities thus affecting its purchasing power. If I ever found a copy of Jastram's "The Golden Constant" I could answer that better, but it is about as rare as a central banker being bullish on gold.

In fact, I would go further and say that gold falls in price not only during deflationary periods but also during disinflationary periods. We have the 1980-2001 bear market in gold as exhibit A for that argument.

Thirdly, I agree that central banks have greatly understated their gold reserves as bar upon bar was sold or leased out to mainly adorn the women of this world (which is probably a better use unless you are the husband paying for it). I would somewhat disagree with the notion that the bullion banks will be forced to settle their loan agreements with gold. I suspect their creditor central banks will quietly accept cash as settlement rather than face their worst nightmare of a derivative crisis brought on by an explosive price spike in gold.

So, the bullish case for gold is established, but what about silver?

First of all, Gary North makes the statement that because silver is fully demonetized but gold is only semi-finally demonetized that this makes a more bullish case for gold. However, such was also the case in the 1970s but silver outperformed gold, so this argument does not seem to hold water. Moreover, central banks may have decided that gold and silver are no longer money, but that doesn't mean they have ceased to be money in identity. Just because some president or prime minister has stood up and said "gold is no longer money" doesn't mean squat to me. As Mark Twain once declared,

"Just because you say so, doesn't make it so!"

I understand Gary North is a free market money man, so he would concur with me that what government says about money doesn't make it so! People trading with each other for millennia agreed gold and silver were money, not some bureaucrat in an oak-panelled office with a fetish for fiat!

Gary North further takes to task the silver deficit argument. Basically, there has been a shortfall between silver mined out of the ground and silver demanded by consumers. This deficit is made up by aboveground stockpiles and recycling of scrap. He is not quite right in claiming this deficit has existed for almost all the 23-year bear market in silver. More like half of that time would be more accurate.

Gary North asks the question that if the deficit argument led to losses for 23 years, why should anyone believe the same argument today?

The answer to that lies in the fact that the deficit only relates to mine supply. With hundred of millions of ounces of silver poured into silver bars during the mania of the late 1970s, one could be ensured of a steady supply of pure silver to make up the shortfall.

But if Gary North thinks this situation can go on forever, he must think these stockpiles miraculously replenish every year. The stockpiles of silver today are significantly smaller than those of 23 years ago! In an ongoing deficit situation, stockpiles diminish. Unless demand falls below mine supply, there will come a day of reckoning when the silver cupboard is bare.

Gary North then revisits the question of gold's own deficit that is being supplied by central bank sales. To this we give our hearty amen and I presume this is given as an example of a real deficit argument. In reply, I say they are both true but once again neither has been expressed in price since gold and silver continue to be supplied from above-ground stocks. To this end, I hold both of the metals in anticipation of the inevitable price explosions (with silver being at a higher megaton rating I may add due to the smaller size of its market!).

And finally he comes to the gold-silver ratio. I said that Gary North's article was providential as it was the gold-silver ratio that I was addressing in my latest newsletter. Unfortunately, we took opposing views on it. He says the gold/silver ratio as a forecasting tool produced only losses from 1980 to 2003.

And in another place he says there was a close correlation for many decades of 15 to one but that was because Federal law set this ratio.

In answer to this idea that the ratio of 15 is set by Federal law, I ask Gary North one or two questions. Why was this ratio of 15 to 1 approached after demonetisation of silver in 1920 and in 1968 and 1980 when both were demonetized? Why did the ratio bounce off this number (give or take a digit) each time as if it was a multi-century support level? Something more than government decree seems to be going on here. Moreover, since these statistics suggest that the gold-silver ratio is not likely to go below 15 then why would Gary North suggest that it was a poor forecasting tool from 1980 to 2003? If 15 is the lowest it can go then the only other direction in such volatile markets is up and that is exactly what happened from 1980-2003 as the ratio increased and gold outperformed silver (in terms of losing value less quickly I hasten to add). Now that I see the ratio on a long-term downward trend, we can say with some confidence that silver will outperform gold for the foreseeable future.

One thing we do agree with Gary North on as regards the gold-silver ratio is that it is not some short to medium term forecaster. It is a long-term indicator and should be treated thus.

Having said all this, Gary North at the end of his article recommends pre-1964 90% silver coins as the best way to buy silver. I assume that was a recommendation for American readers. For Europeans and others, I do not recommend this as the best way to buy silver due to import costs and unless you can guarantee they are recognised as saleable assets in your own home country.

So with that I end my response. Gary North favours a metal portfolio balanced in favour of gold rather than silver. I recommend silver in some significant proportion of a portfolio that is also amply represented by gold. Either way, gold and silver will do very well in the years and even decades ahead.

Roland Watson writes the investment newsletter The New Era Investor that can be purchased for an annual subscription of $99. To view a sample copy of the New Era Investor newsletter, please go to www.newerainvestor.com and click on the "View Sample Issue Here" link to the right. Comments are invited by emailing the author at newerainvestor@yahoo.co.uk.