What Is the Gold-Silver Ratio?
The gold-silver ratio is the comparison of the price of gold to the price of silver. It has been used to measure the relative value between the two precious metals for centuries and has played a significant role in the history of currency and trade. Today, those two metals are among the most frequently traded on commodity markets, with industrial applications ranging from automotive, aerospace and military applications (e.g., each Tomahawk cruise missile contains 500 ounces of silver) to photovoltaic solar cells and semiconductors.
With increased industrial demand and the abandonment of the gold standard, the gold-silver ratio has experienced significant volatility since 1933. However, investors can still use it as a hedging strategy to help identify opportunities for trading gold and silver. That’s because historically, precious metals have served as reliable portfolio hedges during periods of market volatility, economic downturns and recessions.
Read on to learn about the gold-silver ratio, its importance for investing, its limitations and how to best utilize it.
Table of Contents
- What is the gold-silver ratio?
- Why is the gold-silver ratio important for investing?
- How to use the gold-silver ratio for trading
- What are the limitations of using the gold-silver ratio?
- Trading strategies to consider
- The gold-silver ratio FAQs
- Summary of the gold-silver ratio
What is the gold-silver ratio?
The gold-silver ratio is the price of physical gold divided by the price of silver. It represents how many ounces of silver are needed to purchase one ounce of gold. The ratio fluctuates over time due to changes in the supply and demand of these precious metals.
The ratio was first established during the Roman Empire at 12:1, meaning it took 12 ounces of silver to buy one single ounce of gold. Over the years, the ratio has adjusted alongside supply and demand of gold and silver. It reached an all-time high of around 125:1 in April 2020 coinciding with the arrival of the COVID-19 pandemic.
The gold-silver ratio has at times been fixed and at times been set by free market trade.
Why is the gold-silver ratio important for investing?
The gold-silver ratio can provide insights into the relative value of these metals and, along with other considerations, help traders decide whether to buy gold or silver. For example:
- When the ratio is high, it means silver is undervalued compared to gold.
- When the ratio is low, gold is undervalued compared to silver.
Accordingly, investors may be able to predict how the ratio will help them make trading decisions.
How to use the gold-silver ratio for trading
Analyze the history of the gold-silver ratio
Historical gold-silver analysis can help you understand how the ratio has behaved in the past and may offer insights into how it could behave in the future, though as with any investment indicator, it’s not guaranteed.
The historical average gold-silver ratio is roughly 15:1, and the 100-year average is roughly 40:1; these figures are useful long-term averages that can help investors determine the exit from silver to gold, or vice versa.
You can use charts and data to help identify long-term and short-term trends, resistance levels and other important indicators that may help you make trading decisions about whether or not it’s the right time to invest in gold or silver. However, be sure to consider all of the factors beyond what the ratio tells you before investing, including but not limited to:
- Central bank reserves
- The strength or weakness of the U.S. dollar
- Current levels of inflation
- Current interest rates
- Geopolitical unrest
To learn more, read our guide on what drives the price of precious metals.
Learn and monitor the ratio to recognize opportunities
Monitoring the gold-silver ratio can help investors make informed trading decisions. This can be accomplished by attempting to foresee how prices of the two metals are moving. They may trade their gold for silver when the ratio is high, and trade their silver for gold when the ratio is low.
Over time, this can increase the amount of metal they own. However, it’s possible that the ratio will move further in the other direction, making it disadvantageous to trade.
Remember to stay current with market news and events that may impact precious metal prices, such as political instability or economic downturns. Track your profits and losses and adjust your trading strategy based on market conditions and risk tolerance.
What are the limitations of using the gold-silver ratio?
Importantly, the gold-silver ratio shouldn’t be the only tool you use to make investment decisions about trading precious metals. It’s crucial to consider other factors, like those mentioned above in addition to market trends, geopolitical events and economic indicators. Moreover, the ratio does not provide information about the absolute price of gold or silver, but only the relative value between the two.
The gold-silver ratio is affected by economic factors such as crude oil prices, stock market performance, global currency valuations and Treasury yields. These factors can impact the perceived value of gold and silver and, in turn, affect their ratio. In short, like any other strategy, trading the gold-silver ratio comes with risk, and it should be used carefully.
Trading strategies to consider
When it comes to precious metals trading, the gold-silver ratio constantly fluctuates, presenting various trading strategies for astute investors. In the following section, we explore some of those trading strategies that offer ways to potentially capitalize on price differentials, trend movements and overall market dynamics between the two metals.
Mean reversion
Mean reversion is a popular trading strategy focused on buying undervalued assets and selling overvalued ones, assuming that prices will eventually return to their historical averages.
For example, when trading the gold-silver ratio, mean reversion traders may buy silver and sell gold when the ratio is high, or sell silver and buy gold when it’s low, based on the expectation that the ratio will revert to its long-term average. This is typically accomplished by analyzing standard deviations, which suggest how far removed the asset’s price is from its mean price.
Momentum trading
Momentum trading is a strategy wherein traders buy or sell an asset based on its upward or downward trend in price. You can identify these trends by using technical indicators, the most common of which are simple moving averages.
When using this strategy, a trader may buy gold when they identify the start of a potential uptrend in the ratio and sell when they identify a downtrend. This strategy assumes that the trend will continue, and the trader can capture gains by following it.
Hedging
Hedging is a strategy where a trader takes a position to protect themselves from potential losses in another position. This strategy is a means of diversification and can help reduce the trader’s overall risk and protect their portfolio.
As previously mentioned, precious metals act as hedges during economic downturns, market volatility and times of recession. In this sense, using the gold-silver ratio can help investors insulate themselves from potentially outsized losses.
Pair trading
Pair trading involves taking two positions in two different assets with similar characteristics. This strategy allows traders to take advantage of relative price movements between two assets. For example, traders betting that the gold-silver ratio will decrease could take a long position in gold and a short position in silver, thereby enabling them to conceivably profit on the price action of both precious metals at once.
Ratio spreads
A ratio spread is an options trading strategy that entails the simultaneous holdings of unequal long and short options. Investors using this strategy would establish the spread by holding either long or short puts, or long or short calls on the same underlying security (e.g., gold or silver).
In doing so, the number of short positions to the number of long positions establishes the specific ratio. Most commonly, the ratio is 2:1, with twice as many short positions as long long positions. With spread ratios, the positions have varying strike prices but the same expiration dates.
This strategy may suit traders who want to take a neutral position in the gold-silver ratio and profit from changes in the ratio without making a directional bet on either metal. However, this strategy can be complex and requires careful monitoring and adjustment to maintain the desired spread.
These five strategies can be complex, so investors should have a good understanding of options and options strategies before they begin to trade the gold-silver ratio.
The gold-silver ratio has a long history, which dates back to ancient times when it was used by the Greek, Roman and Byzantine civilizations. During the Roman Empire, the ratio was set at 12:1. During the Middle Ages, the ratio was used in Europe to determine the exchange rate between gold and silver coins.
The ratio has fluctuated dramatically over the centuries, ranging from 2:1 to over 100:1. It wasn’t until 1866 that it broke above 20:1 for the first time and has only briefly come below that mark twice, once in 1919 at the end of WWI and again in 1969 when President Nixon permanently severed the U.S. dollar’s link to gold.The gold-silver ratio may increase due to several factors, including economic conditions, supply and demand, mining production, currency fluctuations and investor sentiment. Changes in the ratio have clearly reflected these factors since the start of the 21st century, resulting in a dramatic increase in the gold-silver ratio's volatility.
Economic uncertainty, for example, can drive investors towards safe-haven assets such as gold, causing its price to increase relative to silver. Gold and silver supply and demand dynamics can also impact the ratio. For instance, the ratio may decrease if industrial demand for silver increases while demand for gold remains flat. The amount of gold and silver produced yearly can also affect their relative values.
Summary of the gold-silver ratio
Throughout history, the gold-silver ratio has been influenced by factors such as supply and demand, changes in monetary policies and geopolitical events. Today, it remains a tool used by investors seeking potential trading opportunities with the precious metals.
Monitoring the ratio’s fluctuations and its historical record while combining that with a strong trading strategy can help you recognize opportunities and make informed trading decisions. While the gold-silver ratio is valuable, it shouldn’t be the sole basis for investment decisions. Considering other market indicators and trends is crucial. The ratio is limited regarding absolute prices of gold and silver, but it highlights their relative value.