Trade gold/silver ration
For true commodity enthusiasts, the relationship between gold-silver, gold/silver ration, is crystal clear. For the average investor, it represents a metric that is anything but familiar. In fact, there is significant profit potential in some established strategies that rely on this relationship. Effectively, the gold-silver ratio represents the number of troy ounces of silver required to buy a single troy ounce of gold. This is how investors benefit from trading based on observed changes in this ratio.
Investors use the gold-silver ratio to determine the relative value of silver to gold.
Investors who anticipate where the ratio will move can make a profit even if the price of the two metals falls or rises.
The gold-silver ratio was previously set by governments for monetary stability but now fluctuates.
Alternatives to trading the gold-silver ratio include futures, ETFs, options, CFDs and bars.
What is the gold-silver ratio?
The gold-silver ratio, also known as the coin ratio, refers to the relative value of an ounce of silver to an equal weight of gold. Simply put, it is the amount of silver in ounces needed to buy a single ounce of gold. Traders can use it to diversify the amount of precious metal they have in their portfolio.
Here’s how it works. When gold is trading at $500 per ounce and silver at $5, traders refer to a gold-silver ratio of 100:1. Similarly, if the gold price is $1000 per ounce and silver is trading at $20, the ratio is 50:1. Today, the relationship is fluid and can fluctuate wildly. This is because gold and silver are valued daily by market forces, but this has not always been the case.
The ratio has been set permanently at different times in history and in different places, by governments seeking monetary stability.
The history of the gold-silver relationship
The gold-silver ratio has fluctuated in modern times and never stays the same. This is mainly because the prices of these precious metals experience wild swings on a regular, daily basis. But before the 20th century, governments determined the ratio as part of their monetary stability policy. For hundreds of years before that time, the ratio, often set by governments for monetary stability, was quite stable, between 12:1 and 15:1.
The Roman Empire officially set the ratio at 12:1, and the US government set the ratio at 15:1 with the Coinage Act of 1792.23. In the 19th century, the United States was one of many countries that adopted a standard double-metallic coin system, where the value of a country’s monetary unit was determined by the coin ratio. However, the era of the fixed ratio ended in the 20th century as nations moved away from the bi-metallic currency and finally freed themselves completely from the gold standard. Since then, the prices of gold and silver trade independently on the free market.
Here is a quick overview of the history of this relationship:
323 BC: The ratio stood at 12.5 after the death of Alexander the Great.
Roman Empire: the ratio was set at 12.3
End of the 19th century: The almost universal fixed ratio 15 ended with the end of the bi-metallic era.
1980: In the last major increase in gold and silver, the ratio was 17.
1991: When silver reached a record low, the ratio peaked at 100.
2007: For the year, the average gold-silver ratio was 51.
The importance of the gold-silver ratio
Although there is no fixed ratio, the gold-silver ratio is still a popular tool for precious metals traders. They can, and still do, use it to hedge their bets in both metals – taking a long position in one, while holding a short position in the other metal. So when the ratio is higher and investors believe it will fall along with the price of gold compared to silver, they may choose to buy silver and take a short position in the same amount of gold.
So why is this relationship so important for investors and traders? If they can predict where the ratio will move, investors can make a profit even if the price of the two metals falls or rises.
Investors can make a profit even if the price of the two metals falls or rises by anticipating where the ratio will move.
How to trade the gold-silver ratio
Trading the gold-silver ratio is an activity primarily conducted by hard assets often referred to as gold bugs. Why? Because the trade is based on accumulating larger amounts of metal rather than increasing dollar profit. Sounds confusing? Let’s look at an example.
The essence of trading the gold-silver ratio is to switch holdings when the ratio swings to historically determined extremes. Then:
When a trader owns one ounce of gold and the ratio rises to 100, the trader would sell his single ounce of gold for 100 ounces of silver.
When the ratio then decreased to a level of 50, for example, the commodity trader would then sell his 100 ounces of silver for two ounces of gold.
In this way, our precious metals trader continues to accumulate quantities of metal as he seeks extreme conditions to trade and maximize holdings. Please note that no dollar value is taken into account when trading. This is because the relative value of the metal is considered unimportant.
For those worried about devaluation, deflation, currency exchange and even war, the strategy makes sense. Precious metals have proven that they retain their value in the face of any contingencies that may threaten the value of a nation’s fiat currency.
Disadvantages of Ratio Trade
The difficulty with trading is to correctly identify the extreme relative values between metals. If the ratio reaches 100 and an investor sells gold for silver while the ratio continues to grow and hover for the next five years between 120 and 150. The investor is stuck. A new trading precedent has obviously been created and trading back into gold during that period would mean a reduction in the investor’s metal holdings.
In this case, the investor can continue to increase their silver holdings and wait for a decrease in the ratio, but nothing is certain. This is the essential risk for those trading the quota. This example emphasizes the need to successfully monitor ratio changes in the short and medium term to capture the more likely extremes as they occur.
Options for trading gold/silver ration
There are a number of ways to implement a gold-silver ration trading strategy, all of which have their own risks and benefits.
Futures trading
This means a simple purchase of either gold or silver contracts at each stage of trading. The advantages and disadvantages of this strategy are the same – leverage. The same applies to trading CFDs.
Exchange-traded funds (ETF)
ETFs offer an easier way to trade the gold-silver ratio. Again, the simple purchase of the appropriate ETF – gold or silver – on trading routes is sufficient to implement the strategy. Some investors prefer not to commit to an all or nothing gold-silver trade, keeping open positions in both ETFs and increasing their holdings proportionally. When the ratio rises, they buy silver. When it falls, they buy gold. This prevents the investor from having to speculate on whether extreme levels have actually been reached.
Option strategies
Option strategies abound for the interested investor, but the most interesting one involves a kind of arbitrage. This requires buying put options on gold and call options on silver when the ratio is high and vice versa when the ratio is low.
The bet is that the spread will decrease over time in the high ratio and increase in the low ratio. A similar approach can also be applied to futures contracts. Options allow the investor to put up less cash and still enjoy the benefits of leverage.
The risk here is that the time component of the option can erode any real gains on the trade. Therefore, it is best to use long options to offset this risk.
Tackles and coins
It is not recommended that this trade be carried out with physical gold for a number of reasons. These range from liquidity and convenience to security. Just don’t do it.
Summary
There is a whole world of investment permutations available for the gold-silver ratio. Most importantly, investors need to know their own personality and risk profile. For the hard asset investor interested in the ongoing value of the country’s fiat currency, trading in the gold-silver ratio offers security that they at least know they always have the metal.
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