Gold and silver prices continue to skyrocket as we expected.  Most of the  recent price movements have been driven by supply and demand factors that are  yet to be fully understood by the broader public.  But as prices move ever  higher, the commentary in favor of some kind of precious metals bubble gets  louder.  So, outside of fundamental supply/demand dynamics, is there a  justification for these prices?
First off, gold and silver prices may be  at (gold) or approaching (silver) nominal highs, but are well below  inflation-adjusted highs.  Depending on your definition of inflation, the  inflation-adjusted high for gold is about $2,200 per ounce.  For silver it  is about $850 per ounce.  Both were set in 1980.
When we talk about  fundamental values for both, we are not really talking about any intrinsic  value.  What we are really talking about is their value as alternative  forms of money.  Again, and this point cannot be stressed enough, the price  of gold does not change – the currency you are comparing it to does.  If  the price of gold rises in US dollar terms, this simply means that the US dollar  is losing comparative value as a means of exchange.
In this context it is  entirely appropriate to compare precious metals in inflation-adjusted  terms.  Inflation itself is a monetary phenomenon that is nothing more than  currency debasement.  And so it stands to reason that the more a currency  is debased the more an alternative is to be sought.
Those inflation era  highs can be a good basis of comparison, but it must be remembered that they  were set during double-digit inflation and interest rates.  We are not  there, yet.
In terms of currency alternatives, though, the present time  may be the most dangerous.  The just-concluded 3rd BRICS summit (Brazil,  Russia, India, China, and recently added South Africa) showcased a lot of open  talk about replacing the dollar as the world’s reserve currency.  They even  went so far as to begin discussing details of trade regimes that are denominated  in local currencies instead of US dollars.
This is not the only time a  dollar alternative has been discussed.  In fact, the dollar noise is  growing louder.
How would this all impact gold, and by extension  silver?
For one, any new global currency regime would have to include the  metals – even under the auspices of the International Monetary Fund’s (IMF)  Special Drawing Rights (SDR).  So if we turn to the largest holder of gold,  the United States, we can draw a speculative line between its gold holdings and  the Federal Reserve’s balance sheet.
The US dollar is a function of the  credit extended by the Federal Reserve, which is far above simply the number of  Federal Reserve Notes in existence.  Currently (as of April 14, 2011) the  Fed has extended an astounding 2.7 trillion “dollars” to the financial system, including  $1 trillion in actual currency and $1.18 trillion in bank  reserves.
Backing this currency is $1.37 trillion in US Treasury  Securities, $131 billion in federal agency debt (Fannie Mae and Freddie Mac),  $937 billion in mortgage-backed securities, $43 billion in Treasury currency,  and some other assorted “assets”, including $5.2  billion in IMF SDR’s.  Gold only accounts for $11 billion.
But the  gold stock (certificates) on the Federal Reserve’s books is being valued at the  same price as the 1933 dollar devaluation, $42.2222 per fine troy ounce.   In total, the Federal Reserve is currently using 261,499,000 troy ounces of gold  as “collateral” for the dollar at 78-year old prices.
If we value these  holdings at current market prices ($1,485), the value on the Fed’s books would  be $388 billion, still only 14.3% of the Fed’s liabilities.  To fully back  the dollar with gold would mean a price of $10,337 per ounce.  And that  gives the Fed full credit for its gold holdings.
We know that not all of  the government’s gold is actually in the possession of the government at Fort  Knox.  The US has been leasing gold for years.  The exact proportion  of actual, physical gold to paper claims (leasing agreements) is, and will be,  unknowable.  But if we are talking about a paradigm shift in the  international financial system then paper claims will not be enough.
This may seem like an outrageous proposition, but considering the lack  of support for the dollar right now the conditions are ripening for a Bretton  Woods-style change.  Even if there is a move to SDR’s, there has to be some  collateral behind them far above just financial paper, including US  Treasuries.  In any conversion, the price of gold will have to be adjusted  to any set proportion of capital contributions to the  new international regime(s).
Since the US is the biggest holder (we  think) then it may get the largest credit and/or concessions.  That may  mean some amount of Fed “assets”, including mortgage notes and US Treasuries  will be allowed as currency collateral.  Or it may include other  commodities such as oil – which the US is in possession of in its strategic  reserves.
Whatever may happen, we know that a gold coverage of 14.3% of  all dollars is likely not nearly enough.  Just to get to a 50% collateral  arrangement, the price would have to rise to $5,168 per ounce.  Since  silver is historically related to gold at 16 to 1, that would translate to $323  per ounce of silver.
For many people this line of thinking is  far-fetched and may seem like lunacy and fear-mongering.  Yet these are  exactly the kinds of discussions that foreign governments have been having for  well over a year.  Investors should not sit back and allow recency bias  (the belief that because something has not happened in the recent past it will  not happen at all) to blind them to what is a real possibility.
Context  conditioning is certainly at play – people have now grown accustomed to massive  monetary intervention.  Four years ago the thought of the Federal Reserve’s  balance sheet above $1 trillion was just as offending.  Federal Reserve  purchases of US Treasury debt was thought an absolute impossibility.  So  there has already been a paradigm shift in the dollar’s structure.  Why  should we expect that everyone is on board with it?
Now that we have  become partially untethered to past “rules” and practices of monetary  conventions, can it not be just as likely that the ultimate solution will be in  the opposite direction of the current altered regime?  Fundamental shifts  are both unpredictable and volatile.
Getting back to gold and silver  prices, there is no ceiling in the context of dollar uncertainty.  Being so  far below inflation-adjusted prices provides ample support on its own.  Any  additional probabilities of currency realignments just adds to that  support.  Whether or not the dollar’s reserve currency status is revoked is  only part of the equation.  In the much bigger picture, people around the  world are growing very tired of always getting the short end of universal  debasement and manipulation (and this is not just a US creation).
While  we may not yet have passed the tipping point, we should at least consider that  there may come a time when paper claims on assets will no longer be provided the  same value as real, tangible assets.  Any shift toward that perception,  whether a radical overhaul or even a partial change, requires a fundamental  revaluation of the relationship between currency and metal.