Precious Metals- Updated Silver-Gold Ratio

Precious Metals: The silver-gold ratio

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Gold and silver are always in the news. Recently, the Federal Reserve indicated that it would end asset purchases in October. Raising interest rates is another story. That is not likely to come before the middle of 2015. Low interest rates are a positive for gold and silver. During the heyday of quantitative easing and low interest rates, prices of gold and silver soared to all-time highs. After the last Fed meeting when it became clear that interest rates would remain low the price of gold and silver soared.

Gold is up 10% so far in 2014 while silver has appreciated by only 5%. Thus far in 2014 gold has outperformed silver but it is possible that trend is about to reverse.

Gold and Silver- A special relationship

Circa 3,000 BC the first Egyptian Pharaoh, Menes, declared that one part gold equals two and one-half parts silver. This was the first recorded statement regarding the value relationship between gold and silver. Over the course of history, the relationship has been important.  Some governments adopted a gold standard while others a silver standard as a basis for their monetary systems. The Presidential election of 1896 pitted William McKinley against William Jennings Bryant. McKinley favored a gold standard while Bryant a silver standard. The relationship between these two precious metals is as important today as it was thousands of years ago.

The Silver-Gold Ratio

Many traders watch the value of gold relative to the value of silver to uncover clues as to the price direction of these metals.

Dividing the current price of gold by the current price of silver will establish the current ratio. Another way to think of this relationship is to ask, at today's prices how many ounces of silver does it take to buy one ounce of gold? With gold trading at $1329 an ounce and silver at $21.15, the ratio today stands at 62.84:1.

That is far above the level proclaimed by Menes some five thousand years ago.

Over the course of the past four decades, the silver-gold ratio has traded as high as 93:1 in 1990 and as low as 15.5:1 in 1979. The median level has been 55:1. Although there have been periods where the ratio has extended it tends to revert to that median level over time. One can interpret whether silver and gold are cheap or expensive using this relationship. When the ratio is above 55:1 silver tends to be cheap when it comes to a comparison with the price of gold. When the ratio is below 55:1 gold tends to be cheap compared to the price of silver. Today, at over 62:1 silver is historically cheap.

Recent Market Action May Be Telling Us Something

After the last Federal Reserve meeting on June 17, Chairperson Janet Yellen indicated that interest rates would remain low for the rest of this year. The next day gold and silver prices took off. Gold moved from $1275 to $1322 (an increase of 3.7%) while silver moved from $19.95 to $20.97 (an increase of 5.1%). As one might surmise, the silver-gold ratio moved lower that day.

Silver may lead the next leg up in precious metals

Both gold and silver have been consolidating since the middle of June, and both markets could be preparing for the next leg up to challenge recent highs.

With the silver-gold ratio, trading above the long-term median level silver is historically cheap and may lead another leg of the precious metals rally when it comes. Many professional traders watch this relationship for directional clues. Those interested in precious metals may want to use the silver-gold ratio as part of their investment calculus.

Recent action

In 2015, the bear market in precious metals continued with both gold and silver falling to multi-year lows. In August, gold fell to lows of $1072.30 and silver traded down to $13.91. The silver-gold ratio moved to highs of almost 80:1, the highest level since 2008.

This relationship tends to move higher during bear market periods and lower when prices appreciate. The volatility of the ratio is likely because silver is a more volatile metal and tends to attract speculative interest on both the up and downside.

Silver tends to lead gold. Therefore, it should come as no surprise that the silver-gold ratio was trading at historically high levels in 2015. As of October 23, 2015, it stood at around 73:1, from a historical perspective, either gold is too expensive, or silver is too cheap. Additionally, the level of the spread validates the bear market in the precious metal sector.

Other factors contributing to the divergence from historical norms in the spread are the strength of the U.S. dollar and sluggish global economic conditions, particularly in China. The level and volatility of the silver-gold ratio can provide valuable clues as to the overall direction of precious metal prices. At its current level, it tells us that the bear market in precious metals has not yet ended.