Trading Off Silver/Gold Ratio
There can be tremendous opportunities from investing in precious metals, assuming you do it well. Gold can be an excellent form of "natural insurance," by preserving your wealth in times of inflation, or acting as a safe-haven asset when political, military, or economic risks rear their ugly heads.
As well, silver (which acts like a hybrid, part way between an industrial metal, and a precious metal), can often gain when gold rises, or increase in price when industrial output runs high. Like gold, silver has reached an all-important tipping point — specifically (and only very recently), we have reached both peak gold and peak silver.
You have no doubt heard of peak oil. Well, this is currently the precious metals equivalent of that!
New mining operations are fewer and further between. Meanwhile, current production sources have dug through all the "low-hanging fruit," extracting the easier and more-significant finds, leaving only the continuously declining output.
Yields are in decline, and the costs to find and extract those metals is on the rise (although somewhat offset by advancements in technologies used during the process).
In other words, worldwide, we will never be able to mine and produce precious metals at our current rate, or a higher one. There will only be a decline.
In addition, for the first time (ever), ALL silver produced is being used up for industrial uses. The metal is going into things like:
- eating utensils
- water filters
- solar panels
- soldering pipelines
- automobile engines
- industrial chemicals
- and more...
Gold, on the other hand, has fewer total uses, but really shines as an investment metal. Think jewelry and Central Bank purchases of solid bars from many of the world's nations. It is also widely seen as a flight-to-safety asset.
War breaks out? European Union breaks up. A top political leader goes missing? You will want to own gold, and everyone will be buying it.
In fact, any time you may want to buy gold, it may already be difficult to get. When something happens to drive people's investment dollars into the precious metal, typically the demands significantly outpace any available supply. This means the only way to get actual physical gold is to buy it ahead of time when no one else is having the same thought!
However, people can be much too focused on the specific metals "in a vacuum." They may think gold will increase, so buying gold would be a good investment. Alternatively, if they expect greater silver demand, they would buy more of that metal.
However, what can be much more profitable, and provide additional clarity, is to keep an eye on the ratio of value between the two of them. Specifically, the silver to gold ratio. That ratio simply compares how much silver is required to purchase an amount of gold. So, for example, if it would take 75 ounces of silver to buy one single ounce of gold, then the ratio would be at 75.
It is important to watch and know the literal prices of the commodities, but it can add another dimension to your analysis by tracking the changes in their worth when compared to one another.
Think of it like choosing a restaurant for dinner; one has better food, but is more expensive; the other serves lower quality fare, but has a much lower price.
You may not know at first which one is the better value. However, if the low-quality eatery suddenly jacks up their prices, or the high-quality establishment drops their prices significantly, then you would suddenly know which one represented superior value.
Watching the silver to gold ratio can provide extremely useful insights into both precious metals.
Historically, it would have taken approximately 30 to 40 ounces of silver to buy one single ounce of gold.
This typically means that a ratio above 60 represents undervalued silver, while a ratio below 20 demonstrates undervalued gold. However, keep in mind that this entire concept plays out over the very long term (years, not months).
The ratio can be way too high, but that doesn't typically mean it will return to more reasonable levels within months (although it very often might). More likely, it would take a few years, but given a long-term outlook, the ratio always returns towards historical norms.
In fact, even in the "way too high" scenario, we outlined above, it could possibly push even further into extreme territory. A ratio of 80 (which is extremely high) could go to 90, or even higher (although unlikely) before it eventually returns to more historically normal levels.
As well, so many geopolitical and global events will factor into the prices of either of the metals:
- a stronger or weaker US dollar will affect both metals somewhat equally
- an increase in interest rates will result in a decrease in gold prices
- a recession means lower industrial activity, thus less demand for silver to make products, and therefore lower prices of that metal
- the outbreak of wars, or rampant inflation, or a stock market crash is typically very good for flight-to-safety assets, such as gold
In other words, depending on the geopolitical and global tides, all commodities can feel effects on their prices. Even so, regardless of the major influences on the prices of gold and silver, they will always try to return towards their more-common ratio level of 30 to 40... although it may take a year or two once they start returning to that range.
In 1915, you could have traded 38 ounces of silver in exchange for one single ounce of gold. In 1940, near the beginning of World War II, gold soared as a safe haven asset, and the ratio was 97 to 1.
With inflation running wild in 1979, the Federal Reserve Chairman, Paul Volcker, raised interest rates to 21 percent. This resulted in driving down prices of gold, which eventually created the lowest-ever silver to gold ratio of 14.
While trying to predict future moves in the prices of the individual metals can be difficult, it may be much easier to invest based on the relationship between the two. When the silver to gold ratio is low (less than 30), then silver itself will typically rise faster than (or fall slower than) any moves you see in gold.
When the ratio is high (greater than 65), then silver will typically fall faster (or increase slower in the case of rising metals prices) than any moves you see in prices of the more-expensive metal. For example, if the ratio is 80 to 1, and gold jumps 3 percent, silver may barely even increase at all.
The relationship between the two metals is what is important. Continuously, although only from a long-term perspective, the ratio is always pushing to return to the historical average range of between 30 to 50.
It could be argued that when the ratio is low, gold is undervalued in relation to the other metal. When the ratio is high, silver is the more undervalued of the two.
In March of 2016, the silver to gold ratio hit a whopping 80.57. If you had one ounce of gold, it was worth 80.57 ounces of silver.
That level was almost the highest it has been, since 1991, when it hit 100! Within seven years, the ratio had fallen all the way down to 47 — this happened through a combination of gold rising faster, or silver falling faster, proportionately until the ratio had normalized at more historically representative levels.
In March, when one ounce (or one bar or one coin) of the more expensive metal could purchase 80.57 ounces (or bars or coins) of the less expensive metal, I expressed the ratio was out of whack.
Silver would certainly need to rise at a faster rate than gold... and that is exactly what happened next until the silver to gold comparison approached a more realistic value of 67.
That all played out over a quick four months. Even at these new, more realistic levels, there was still plenty of room for an even more impressive move. The ratio is still too high, and I expect it to normalize further (whether through greater increases in silver, or larger declines from gold, comparatively).
This outlook is for much higher gold prices.
In such an environment, the only way for the silver to gold ratio to normalize towards historically normal levels is for silver to soar by even more than it's counterpart.
If gold goes up 100 percent, silver will need to rise by even more than that percentage. In that scenario, silver would increase by 200 percent just to bring the ratio back to a more appropriate 40 to 1.
One approach to playing (meaning trading) the silver to gold ratio, for some significant profits, is to make decisions based on the ratio itself as you would trade back and forth between the two commodities.
If one metal is cheaper compared to the other, you would sell the "overpriced" one, and move the proceeds into the "undervalued" one. Then, when the ratio goes the other way in a year or two, you do the exact same thing again, selling the overpriced commodity for underpriced one.
For example, you sell one ounce of gold when the ratio is at 80, which gives you 80 ounces of silver. Then, a few years later when the ratio hits 20, you could sell those 80 ounces, in exchange for four ounces of gold.
You just quadrupled your investment, going from one ounce to four in just two trades. Now, imagine doing that just a few more times, and even though this is a very long-term strategy, it could potentially be very lucrative.
Of course, any such strategy might become problematic once fees, insurance, trading commissions, and slight variances in pricing are factored in. For example, even an excellent, well-respected online precious metals dealer like GoldSilver.com is going to charge you a tiny bit extra, but everyone does that, and their fees are some of the lowest.
However, trading in and out of certain assets, such as the Sprott Physical Gold Trust, and also the Sprott Physical Silver Trust, makes it easy to move between the two, just like trading stocks, and they are backed by the actual metals themselves. If you purchase 24 ounces of silver, there are actually 24 ounces of real, physical silver, kept in the National Vaults for you.
As well, some Exchange Traded Funds (ETFs), like SLV and GLD, also can generate a similar effect when trading off the silver to gold ratio. However, keep this important point in mind — there is a huge difference between actual physical metals (such as those which you can hold in your hand), and "paper metals," like ETFsFor example, if you purchase GLD, you do not actually own any gold Rather, you have an investment on paper which tries to base its value on the metal, but truly all you've purchased is a piece of paper or a contract.
In many cases, some of these paper metal investments have as many as 200 people (or even more), all laying claim to the same ounce. In other words, they lay no realistic claim to any actual metal.
As such, you could encounter issues if several individuals all try to get the actual gold or silver at once. More likely, since they are not "realistically" connected to actual supplies (which are limited by nature itself), and which instead are completely unlimited (they can create as much GLD or SLV as they choose), the can be prone to manipulation.