12 Nov Using the Gold-to-Silver Ratio to Inform Your Trades
Unless you’re a seasoned commodities trader or a die-hard gold bug, you may not be that familiar with the gold-to-silver ratio. If not, read on, as we’ll explain what it is, how it’s traditionally interpreted, and how you might use it to inform your precious metals trades or allocations.
What is the Gold-Silver Ratio?
The gold-silver ratio is a figure that tells you how many ounces of silver is equivalent to one ounce of gold in terms of price. For instance, at the start of 2019, gold was trading around $1,279.89 while silver’s price was at $15.49. If we divide the price of gold by the price of silver, we get a gold-silver ratio of 82.62.
This tells you that it takes 82.62 ounces of silver to purchase one ounce of gold. Now what; how might you use it?
Scenarios in Which the Gold-Silver Ratio May Be Applicable
Here are three practical scenarios in which the gold-silver ratio might be useful.
- Analyzing the precious metals market: if you’re trying to determine which metal might be outpacing the other, the gold-silver ratio can help provide a clear and informative big-picture context.
- Tactically rebalancing your metals exposure: If you are looking to underweight or overweight silver or gold in order to capture a better return, the gold-silver ratio trend might help you determine which metal may be trending up or down.
- Trading the spread between gold and silver: Perhaps you want to go short one metal and long the other, the gold-silver ratio might be useful given that your overall assessment (both fundamental and technical) is correct.
- Forecasting gold and silver price trends: This is tricky territory, but many (if not most) traders use the gold-silver ratio to speculate price trends. We’ll cover this at length later in the article.
So, how might you go about interpreting the ratio? For instance, if the ratio rises, does that mean that gold prices are going up while silver prices are going down? No, it doesn’t, and this is where the ratio can get confusing.
How to Interpret the Gold-Silver Ratio
There are a few ways to interpret ratio fluctuations. Here are the more traditional interpretations:
Rising Ratio: gold is outpacing silver
- If both metals are falling, then silver is falling faster than gold (Figure 1).
- If both metals are rising, then gold is rising faster than silver (Figure 2).
Figure 1: Gold-silver ratio – August 28 to November 5, 2019
Figure 2: Gold-silver ratio – May 9 to July 16, 2019
Falling Ratio: silver is outpacing gold
- In most cases, silver outpaces gold while both metals are rising (Figure 3).
Figure 3: Gold-silver ratio – July 22 to October 1, 2019
As you can see, the gold-silver ratio can help inform you about gold and silver prices by providing an additional measure or context. But this context concerns the present and the past.
Can the gold-silver ratio be used as a predictive indicator? Possibly, but be careful!
Using the Ratio to Forecast Gold and Silver Prices
Here’s the “meat and potatoes” of gold-silver ratio applications. Like all forecasts and predictions, the accuracy of the model is always in question, never certain, but certainly useful if taken as an anticipatory (and not predictive) measure.
In the case of gold and silver, price forecasts are based on an “average”–namely, the average gold-silver ratio. The problem is that this average tends to change over time. For example, take a look at Figure 4 below.
Figure 4: Gold-silver ratio from 1915 to 2019 (Image source MacroTrends)
According to metals industry news site, Mining.com, the average gold-silver ratio in the 20th century stood at 47:1. If you believe that all extreme fluctuations tend to fall back toward the average, then you might expect the ratio to revert back to this level. Over the years, this expectation might have helped many investors time their metals allocations.
But the average may be shifting–we can’t be certain as of yet whether this shift is permanent or temporary. Over the last 20 years, the average has risen to 60:1. Right now, the ratio stands at around 83:1–a high level.
So, does this mean that the ratio might fall, reverting to the average, sending both metals higher with silver taking the lead? It might, or it might not.
At this point, you might want to consider whether such a trade fits within your futures strategy. Plus, don’t forget the fundamental factors affecting these markets–the influence of central bank monetary policy on gold and silver prices, the historical tendency for silver demand to rise after a recession (as manufacturing revs up), fluctuations in the dollar’s nominal value versus its relative purchasing power, and investor sentiment toward gold and silver as “safe havens.”