Trading off the Gold-Silver Ratio
Investing in precious metals can present tremendous opportunities if pursued wisely. Investors have long used gold as a form of "natural insurance," preserving wealth during times of inflation or when political, military, or economic risks arise. And silver, which can operate like a hybrid of an industrial metal and a precious one, will often gain when gold rises, and likewise increase in price when industrial output runs high.
But there's also a way to find profit in the relationship between gold and silver. Learn about the gold-silver ratio, and how savvy traders trade the spread.
What Is the Gold-Silver Ratio?
The gold-silver ratio 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 75.
Watching the gold-to-silver ratio can provide extremely useful insights into both precious metals, which can be used to your advantage.
While it is important to watch and know the prices of the commodities themselves, it can add another dimension to your analysis by tracking the changes in their worth when compared to one another.
The ratio increases when the value of gold rises faster than the value of silver. It decreases when the value of silver rises faster than the value of gold.
Are Gold and Silver Still Good Investments?
Gold is generally viewed as a global currency, while silver is often used in industrial applications. This difference means that, while the price of the two metals is often correlated, there is room for variation in direction.
Gold is valuable as an investment metal, widely seen as a flight-to-safety asset. When currency values change or the stock market experiences nerve-wracking volatility (perhaps due to global crisis, geopolitical moves, or other causes), gold is the go-to for many investors.
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.
Investors also trade gold to take advantage of daily price movements.
Meanwhile, demand for silver continues, as this metal is being used to manufacture a wide variety of items, including:
- Eating utensils
- Water filters
- Dentistry components
- Solar panels
- Soldering pipelines
- Photography components
- Automobile engines
- Industrial chemicals
However, mining yields are in decline, and the cost to find and extract these metals is on the rise (although somewhat offset by advancements in technologies used during the process). In other words, 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.
Also, so many geopolitical and global events 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 gold prices
The Gold-Silver Ratio Over Time
Historically, it would have taken approximately 30 to 40 ounces of silver to buy one single ounce of gold.
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%. This resulted in driving down prices of gold, which eventually created the lowest-ever silver to gold ratio of 14 to 1.
In 1991, the ratio hit 100. But within seven years, the ratio had fallen all the way down to 47.
By 2016, the silver to gold ratio swung the other way again, topping 80. If you had one ounce of gold that March, it was worth 80.57 ounces of silver.
In March 2021, the gold-silver ratio was 65, having fallen from 125 a year prior during the height of the Covid-19 crisis
Strategies for Trading the Gold-Silver Ratio
There are a few different ways for traders to take advantage of the value difference between gold and silver.
Trade the Spread Between Gold and Silver
One approach to trading the silver to gold ratio 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 the underpriced one.
For example, say 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.
Your profit will likely be less once fees, insurance, trading commissions, and slight variances in pricing are factored in.
Trade the Ratio With ETFs
Another strategy for trading off the gold-to-silver ratio is to trade exchange-traded funds (ETFs). These funds are traded on the market the same way stocks are; investors can buy or sell according to their own strategy, holding whichever positions suit their goals.
For example, trading some ETFs, such as iShares Silver Trust (SLV) and SPDR Gold Shares (GLD), generate a similar effect when trading off the silver-to-gold ratio. Trading gold and silver ETFs lets investors take advantage of price movements in a simple way.
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 ETFs. For example, if you purchase the GLD ETF, you do not actually own any gold. Rather, you have an investment on paper which tries to base its value on the metal, but you yourself don't own the underlying metal.
The Bottom Line
Trading off the gold-silver ratio can provide profits to investors even when the price of the two metals falls. By understanding the relationship between the price of gold and silver, investors can find opportunities no matter the price.
As you learn to gauge the relative value of these metals in relationship to each other, you may find trading strategies to suit your risk profile while opening up great potential for profit.