Trading the Gold-Silver Ratio

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Trading the Gold-Silver Ratio

The gold-silver ratio effectively shows the amount of ounces of silver required to purchase one ounce of gold.

The gold-silver ratio is common language among hard-asset enthusiasts. It reflects an obscure indicator that is anything but widely recognized to the typical investor. In fact, certain recognized techniques that depend on this ratio have a significant profit potential.

Here are several ways that investors and traders might profit from changes in the gold-silver ratio.

Key Takeaways

  • The gold-silver ratio is used by investors to estimate the relative worth of silver to gold.
  • Investors who predict where the ratio will go may benefit whether the prices of the two metals fall or climb.
  • Governments used to establish the gold-silver ratio for monetary stability, but it currently varies.
  • The ratio is often used by precious metals traders to hedge their bets on both metals.
  • Futures, ETFs, options, and pooled accounts may all be used to trade the gold-silver ratio.

What Is the Gold-Silver Ratio?

The gold-silver ratio, also known as the mint ratio, refers to the relative value of an ounce of silver to an equal weight of gold. Put simply, it is the quantity of silver in ounces needed to buy a single ounce of gold. Traders can use it to diversify the amount of precious metal they hold in their portfolio.

Here’s how it works. If gold trades at $500 per ounce and silver at $5, traders refer to a gold-silver ratio of 100:1. Similarly, if the price of gold is $1,000 per ounce and silver is trading at $20, the ratio is 50:1. Today, the ratio floats and can swing wildly.

That’s because gold and silver are valued daily by market forces, but this has not always been the case. The ratio has been set at different times in history and in different places by governments seeking monetary stability.

Gold-Silver Ratio History

In recent times, the gold-silver ratio has changed and never remained constant. This is mostly owing to the fact that the values of these precious metals fluctuate wildly on a daily basis. However, prior to the twentieth century, governments established the ratio as part of their monetary stability policy.

For hundreds of years previous to then, the ratio, which was often set by governments for the sake of monetary stability, was quite consistent, ranging between 12:1 and 15:1. The Roman Empire formally established a 12:1 ratio. With the Coinage Act of 1792, the United States government set the ratio at 15:1.

During the nineteenth century, the United States was one of several nations that adopted an abi-metallic monetary system, in which the value of a country’s monetary unit was determined by the mint ratio. However, the fixed ratio period came to an end in the twentieth century as countries moved away from the bimetallic currency standard and, finally, away from the gold standard completely. Since then, the prices of gold and silver have traded independently on the open market.

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Here’s a quick overview of the history of this ratio:

  • 2022: The ratio changed substantially in 2021-2022, ranging between 65 and 95.
  • 2020: The gold-silver ratio reached 114.77 in 2020, the greatest level since 1915.
  • When silver hit new lows in 1991, the ratio reached over 100.
  • 1980: At the time of the last large gold and silver rise, the ratio was about 15.
  • 1834-1862: Congress changed the ratio from 15 to 16.
  • From 1792 through 1834, the United States used a bimetallic standard with a constant ratio of 15.
  • The ratio was fixed at 12:1 under the Roman Empire.

Why Does the Gold-Silver Ratio Matter to Investors?

Despite the fact that there is no set ratio, the gold-silver ratio remains a popular instrument for precious metals traders. They may and still do use it to hedge their bets in both metals, holding a long position in one and a short position in the other. So, if the ratio is larger and investors feel it will fall in tandem with the price of gold in comparison to silver, they may elect to purchase silver while shorting the same amount of gold.

So, what is the significance of this ratio for investors and traders? Investors may earn regardless of whether the price of the two metals falls or increases if they can predict where the ratio will go.

Gold and silver prices are most often stated per ounce.

How to Trade the Gold-Silver Ratio

Trading the gold-silver ratio is typically done by hard-asset aficionados known as gold bugs. Why? Because the transaction is based on amassing more metal rather than growing dollar-value rewards. Does it make sense? Consider the following example.

The concept of gold-silver ratio trading is to swap positions when the ratio swings to historically set extremes. So:

  1. When a trader has one ounce of gold and the ratio reaches an unprecedented 100, the trader will sell their one ounce of gold for 100 ounces of silver.
  2. When the ratio fell to an opposite historical extreme, such as 50, the trader would sell their 100 ounces of silver for two ounces of gold.
  3. In this way, the trader continues to collect metal, looking for extreme ratio figures to trade and increase holdings.

When making the deal, no monetary value is considered. This is due to the fact that the relative worth of the metals is more relevant than their intrinsic value.

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The plan makes sense for people concerned about devaluation, deflation, currency replacement, and even war. Precious metals have a track record of holding their value in the face of any unforeseen event that threatens the value of a country’s fiat currency.

Using the Gold-Silver Ratio to Trade

A gold-silver ratio trading strategy may be implemented in a variety of ways, each with its own set of risks and benefits.

Futures Investing

This entails either purchasing gold or silver futures contracts outright, or buying one to sell the other if you believe the ratio will expand or shrink. The major benefit (and drawback) of this method is the same: leverage. That is, futures trading only takes a modest amount of money up front to conduct a much bigger deal. For the uninitiated, this may be a perilous undertaking. An investor may use margin to play futures, but that margin can potentially bankrupt the investor.

Exchange Traded Funds (ETFs)

ETFs (Exchange Traded Funds) provide an easy and convenient way to trade the gold-silver ratio. Again, at trade turns, you may implement your plan by purchasing the proper ETF—gold or silver. Some investors choose to maintain open holdings in both ETFs and add to them proportionately rather than commit to an all-or-nothing gold-silver transaction. They purchase silver when the ratio grows. They purchase gold when it falls. This eliminates the need for the investor to guess on whether or not extreme ratio levels have been achieved.

Options Strategies

Investors may also use options methods in gold and silver, many of which entail some type of spreading. When the ratio is high, you may buy puts on gold and calls on silver, and vice versa when the ratio is low. The bet is that the spread will decrease over time in high-ratio climates while increasing in low-ratio climates. Futures contracts may benefit from a similar method. Options, on the other hand, allow the investor to put up less capital while still reaping the advantages of leverage with less risk.

The time decay component of options tends to diminish any genuine profits achieved on the transaction as time passes and the options contracts approach expiry. To mitigate this risk, it may be advisable to employ long-dated options or LEAPS.

Buying actual gold entails the additional expense of storing it. Gaining exposure to gold via ETFs and gold company equities may be a better financial move.

Pooled Accounts

Commodity pools are vast, private holdings of metals that are offered to investors in a range of currencies. The same tactics that are used in ETF investing may be used here. The benefit of pool accounts is that the investor may get the real metal anytime they want. This is not the situation with metal ETFs, which need very high minimum holdings in order to obtain physical delivery.

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Gold and Silver Bullion and Coins

For a variety of reasons, it is not suggested that this exchange be completed using actual gold. These include liquidity, convenience, and security. Simply do not do it. You can acquire and hold actual gold and silver for long-term investment goals, but trading in and out of these metals is complex and costly.

How Is the Gold-Silver Ratio Calculated?

The gold-silver ratio is derived by dividing the current gold price by the current silver price. This will show you which metal’s value is rising in contrast to the other.

Why Is the Gold-to-Silver Ratio So High?

The gold-to-silver ratio isn’t always favorable. It varies over time based on a number of circumstances, and it may be fairly low. In general, it is high because there is greater demand for silver than for gold across the globe. Silver use is more prevalent than gold usage.

What Is the Gold-to-Silver Ratio Today?

As of August 2022, the gold-silver ratio was about 90:1.

What Are Some Limitations of Using the Gold-Sliver Ratio?

The issue with the trade is accurately detecting the metals’ excessive relative values. If the ratio reaches 100 and an investor sells gold for silver, and the ratio continues to rise, hovering between 120 and 150 for the following five years, the investor is trapped. A new trading precedent seems to have been established, and trading back into gold within that time period would imply a reduction in the investor’s metal holdings. In this instance, the investor might continue to add to their silver holdings while waiting for the ratio to fall, but nothing is certain. This is the primary risk for individuals who trade the ratio. This example shows the need of properly monitoring ratio changes in the short and medium term in order to capture the more probable extremes as they occur.

The Bottom Line

The gold-silver ratio trader has access to a vast array of investment options. What matters most is that the investor understands their individual trading personality and risk profile. The gold-silver ratio transaction provides the assurance of knowing, at the very least, that they always hold the metal for the hard-asset investor worried with the continuous worth of their country’s fiat currency.

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