In trading terminology, the ‘gold-silver ratio’ denotes how many ounces of silver would be needed to purchase one ounce of gold at any given time. In other words, it’s a measurement of the strength of the price of gold relative to that of silver on the financial markets.
As two of the most valuable precious metals on the planet, these commodities have a long and closely related history going back centuries, and many modern forex and commodity traders still rely on their relative levels of supply and demand as an indicator of market’s strength and future direction.
Let’s examine the relationship between the two metals in more detail:
What is the Gold-Silver Ratio?
In order to figure out the gold-silver ratio at any given moment, simply divide the price of gold (per ounce) by the price of silver to get your real-time ratio — at the time of writing, it would look like this:
This means that the gold-silver ratio is currently around 71.7:1 — meaning you could buy more than 71 ounces of silver for the same price as a single ounce of gold.
Conventional wisdom states that when the ratio returns a notably high figure (like above), this means that traders should focus their investment on silver; for instance, when silver is going (comparatively) cheap, you’ll likely be able to offload it at a higher price in the near future.
On the other hand, a lower ratio tends to indicate that gold is on the rise — as you can buy less of it for the equivalent amount of silver — and that it may be a good time for speculators to jump on the gold bandwagon before the price appreciates further.
Indeed, many seasoned investors often look to trade their silver for gold as the ratio evens out. Essentially, if you invest in silver when it’s cheap relative to gold and then sell it to buy gold later — at such a time when silver becomes overvalued relative to gold — you will often make more successful trades than if you were simply trading with both metals separately without using the ratio as an informal barometer of value.
Further reading: https://articles.royalmintbullion.com/gold-silver-ratio-explained/
A Brief History of the Gold-Silver Ratio
The gold-silver ratio has been in a constant state of flux for most of the last century, owing to the fact that the two metals themselves regularly experience shifts in value according to investor demand and geopolitical events. However, prior to the 1900s, many world governments actually set fixed rates for the ratio as part of their wider monetary policies in a bid to promote financial security, which rendered the ratio less susceptible to influence by market forces.
For example, the US Government brought in a static ratio of 15:1 as part of the Coinage Act of 1792 before relying on the discrepancy between the two metals’ value as the basis for its bi-metallic currency system during the 1800s — and, going back even further, even the Roman Empire is documented to have implemented a fixed gold-silver ratio, reportedly set at 12:1.
Remarkably, research by the US Geological Survey suggests that there’s around 17.5 times more silver present in the Earth’s crust than gold, which goes some way into assessing why the ratio always naturally tended to hover between 12:1 and 18:1 during the fixed-ratio era.
After a prolonged period of prominence, the fixed ratio mechanism was phased out over the last hundred or so years as many countries gradually moved away from the bi-metallic system (and as technology progressed, away from the gold standard in general towards more electronic financial structures).
Eventually, the prices of both gold and silver came to be relieved of the constraints of government interference altogether and are now sold as completely separate commodities on the free market, with their prices dictated by supply and demand like any other product or asset.
How to Take Advantage of the Gold-Silver Ratio When Trading
The key thing to understand about the gold-silver ratio is that it is mainly utilised by traders who specialise in hard assets, especially gold. Consequently, the name of the game is to acquire as much gold as possible over the long term without paying much attention to the changes in its monetary value on the market (as many gold aficionados consider gold to be a reliable, recession-proof store of value and thus an evergreen investment).
For example, one straightforward way to leverage the ratio would look something like this:
· If a gold trader were to see the ratio has widened to the unusually high level of 1:100 (as it famously did in 1991), he could sell a single ounce of gold for one hundred ounces of silver.
· Now in possession of one hundred ounces of the less-valuable metal, the trader would then wait for the ratio to narrow substantially again, let’s say to 1:50.
· At this opposite extreme, the trader would then sell his 100 ounces of silver for two ounces of gold — in doing so, he’s now doubled the amount of gold in his possession without spending any extra capital.
The above is a simplistic instance of how the ratio can be used to accrue assets — but the main takeaway is how traders essentially take advantage of the ratio by shifting their capital from one metal to the other as the value differential gradually shifts between extremes.
And once again, for emphasis — notice how the real-world monetary value of the products never needed to enter the equation!
Further reading: https://www.dailyfx.com/gold-price/trading-the-gold-silver-ratio.html
What are the Risks Associated with the Gold-Silver Ratio?
While the gold-silver ratio principle can be a handy guide for traders looking to specialise in metals, keep in mind it’s not an exact science; what qualifies as a significant or extreme widening/narrowing of the values is a subjective call and there’s no sure-fire way to tell by the ratio alone where the markets will be heading next.
For instance, even if the ratio were to hit the 1:100 mark, a trader would have no way of knowing if the values were likely to remain at such a distance long term, or even widen further to 1:125 or 1:250 in the face of a new market paradigm.
If this happens and you’ve gotten impatient and sold your gold for silver, you’re going to be faced with a near-impossible task converting back into gold without incurring losses to your metals portfolio — instead, you’d likely have to wait a long time for an opportune tightening in the ratio before buying gold again. This is the risk you take!
Further reading: https://www.forbes.com/sites/forbesfinancecouncil/2020/05/26/trading-the-gold-silver-ratio-during-times-of-crisis/#5feac4936c94
Use at your own risk disclaimer
The content contained herein does not construe any form of advice and the user must not take this as such. We do not accept any liability for the direct or indirect usage of the content held in this article. We strongly advise that you obtain independent financial, legal and tax advice before proceeding with any currency or spot metals trades.
