Gold to Silver Ratio: Is Gold glittering more than Silver?

 

What is Gold to Silver ratio?
The Gold to Silver ratio is widely calculated in the international arena by investors by dividing current price of Gold per ounce with the current price of Silver per ounce. In simple words, gold to silver ratio is the amount of silver it takes to purchase equivalent unit of weight of gold. Assuming a hypothetical scenario, if the price of Gold is 1000 USD per ounce and Silver is 20 USD per ounce then the ratio comes out to be 50 (i.e.1000 / 20). This by normal mathematics suggests that precious metals may adjust their prices to their long term averages when the ratio reaches to its extreme levels.
Investors use the ratio as a parameter to ascertain the relative change in the price of one bullion metal to that with another.

Significance of Gold Silver ratio
Investors who trade in Gold and Silver track the ratio as a signal for the right time to buy or sell a particular metal. When ratio is high, as in current situation, it has been trading near to its highest level since October 2008 indicates that it is time to go long on silver and short on gold. In other terms, silver looks relatively cheaper than gold. Conversely, when the ratio is low then reverse trade can be initiated. However, one should not forget to consider that recent high value of ratio may or may not be peak and hence the traders should consider their risk if incase the ratio fluctuates too wildly. Typically, ratio serves as an impetus for diversifying holdings. Hence if one of holdings goes unfavorable, then alternate investments will take care of losses.

History:

  • 2007 – For the year, the gold-silver ratio averaged 51.
  • 1991 – When silver hit its lows, the ratio peaked above 100.
  • 1980 – At the time of the last great surge in gold and silver, the ratio stood at 17.
  • End of 19th Century – The nearly universal, fixed ratio of 15 came to a close with the end of the bi-metallism era.
  • Roman Empire – The ratio was set at 12.
  • 323 B.C. – The ratio stood at 12.5 upon the death of Alexander the Great.

 

When currencies were gold- and silver-based holdings, the ratio was fixed. Governments who recognize gold and silver coins as legal tender follow the bimetallic standard as their monetary system. Central banks were in charge of setting or fixing, the gold/silver ratio which provides stability to the currency markets. For example, during the Roman Empire, the gold/silver ratio was fixed at 12/1, or 12 pieces of silver to one gold piece. By the 19th Century, the ratio saw a general setting of 15/1. This was likely because many countries were using gold- and silver-backed currencies. For instance, France and the United States (among others) assigned statutory limits on what the ratio could be.

One more reasons for fixed ratio was the estimates that US Geological Survey made saying that quantum of Silver reserves in the earth’s crust should be approximately 17 times to that of Gold. This is also supports the idea of fixed ratio in pre-1900 era.

However, the era of the fixed ratio ended in the twentieth century as nations moved away from the bi-metallic standard and, eventually, off the gold standard entirely. With the gold standard, countries agreed to convert paper money into a fixed amount of gold.

Britain stopped using the gold standard in 1931, and the U.S. followed suit in 1933, finally abandoning the remnants of the system in 1971. The gold standard was replaced entirely by fiat money in 1973. Fiat
money describes a currency used due to a government order, or fiat, that the currency is acceptable as a means of payment. The chart showing movement of Gold to silver ratio post 1973 is depicted below.

Risk Returns associated with the trades

One should understand the dynamics of the trades done in bullion metals on the basis of ratio. Gold and Silver trade nowadays more in sync but there can be extreme volatility phase too attracting opportunity to traders and investors to take benefit. However one should understand that trades are initiated on expectations of accumulating greater quantities of the metal and not on increasing currency-value profits.

Currently ratio quotes around 85 which is near to its decade high. This is initiated from the lows near 35 in 2011 (refer chart below). Silver’s 16 percent slump this year, almost double the loss for gold, has taken it to the cheapest level versus the yellow metal since 2008. If one assumes that ratio can correct from the current levels then he or she can initiate trade by selling gold and buying silver. However, if ratio expands further on higher side towards 120 or says 150 then one gets stuck with the position. However, one could always continue to add to one’s silver holdings and wait for the contraction in the ratio. However, nothing is certain. Below is the chart of MCX Gold / Silver ratio. Below that we have International Gold to Silver spot price chart for last decade.

 

Trading Strategies:

1) Futures Positions

Trading in gold and silver is more preferable nowadays in Futures on commodity exchanges. One can take positions in the contracts expiring in the same month. However, trading in futures always carry an inherent risk of leverage.

2) ETFs (Exchange Traded Funds)

ETFs offer easy way to trade in small quantities. The simple purchase of appropriate ETFs will help investors to suffice its needs.

3) Options Strategies

In India, trading in options in gold and silver are still out of the flavor. Globally traders can initiate arbitrage by buying Puts of the Gold and Calls on Silver when the ratio is high as in current scenario. However, risk in trading with options is time value may erode the possible profits. Further to play with the ratio strategy one needs to have long dated options.

4) Physical Trading

Buying and selling in coins (as generally seen in Indian markets) has inherent risk ranging from liquidity, availability, security and convenience to do the same.

Recent Fundamental:

Possibility of rising interest rates in US and strengthening dollar may keep bullions under pressure especially yellow metal. Further the trade war concerns and turmoil of emerging markets may reduce the industrial demand for the Silver.

 

Prakash Modi

Author: Prakash Modi

Prakash Modi is AVP- Advisory at Narnolia Group. He is MBA in Finance and has more than 13 years of rich experience as an Investment Advisor to retail, HNI and institutional clients in equity and commodities.

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