Investing in precious metals can present tremendous opportunities if pursued wisely. Investors have long used gold as a form of “natural insurance,” preserving wealth during times of inflation or when political, military, or economic risks arise. And silver, which can operate like a hybrid of an industrial metal and a precious one, will often gain when gold does, and likewise, increase in price when industrial output runs high.
But there is also a way to find profit in the relationship between the silver rate and gold rate in UAE today.
For the hard-asset enthusiast, the gold-silver ratio is common parlance. For the average investor, it represents an arcane metric that is anything but well-known. The fact is, that a substantial profit potential exists in some established strategies that rely on this ratio.
The gold/silver ratio is the amount of silver needed to buy an ounce of gold. The relationship is used by many precious metal investors and gold traders as a fundamental indicator for determining the best time to buy or sell.
If the gold-silver ratio is high, it means that it is the right time to buy silver, since the ratio is more favourable to silver. For example, assuming a gold-silver ratio of 50 to 1, investors would have to only part with 1 ounce of gold to acquire 50 ounces of silver. Similarly, when the ratio is lower, it means that the gold price has fallen, and it is therefore time to invest. Precious metal traders can use this ratio to diversify their trading portfolios.
What is the average gold/silver ratio?
In the modern era, the average price ratio between the two precious metals stands at around 55:1, as it was also at the beginning of 2020. The highest level ever recorded was in 1990 and the lowest in 1979. Historically, when the ratio is below its average level, silver is considered cheap compared to gold; on the other hand, when the ratio surpasses its average, silver is considered expensive.
The chart below shows the price fluctuations of the gold/silver ratio between 1913-2021.
Source: Bullion Vault via US Mint
Throughout 2020, the risk aversion tendency in the markets of all asset classes has pushed the price of silver to its lowest level since 2009, causing it to fall below $12 per ounce, which has sent the gold/silver ratio to a new all-time high.
How to Trade the Gold-Silver Ratio
Trading the gold-silver ratio is an activity primarily undertaken by hard-asset enthusiasts often called gold bugs. Why? Because the trade is predicated on accumulating greater quantities of metal rather than increasing dollar-value profits. Sound 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. So:
- When a trader possesses one ounce of gold and the ratio rises to an unprecedented 100, the trader would sell their single gold ounce for 100 ounces of silver.
- When the ratio then contracted to an opposite historical extreme of 50, for example, the trader would then sell their 100 ounces for two ounces of gold.
- In this manner, the trader continues to accumulate quantities of metal seeking extreme ratio numbers to trade and maximize holdings.
Note that no dollar value is considered when making the trade. That’s because the relative value of the metal is considered unimportant.
For those worried about devaluation, deflation, currency replacement, and even war, the strategy makes sense. Precious metals have a proven record of maintaining their value in the face of any contingency that might threaten the worth of a nation’s fiat currency.
Limitations of the Ratio Trade
The difficulty with the trade is correctly identifying the extreme relative valuations between the metals. If the ratio hits 100 and an investor sells gold for silver, and the ratio continues to expand—hovering for the next five years between 120 and 150—then the investor is stuck. A new trading precedent has apparently been set, and to trade back into gold during that period would mean a contraction in the investor’s metal holdings.
In this case, the investor could continue to add to their silver holdings and wait for a contraction in the ratio, but nothing is certain. This is the essential risk for those trading the ratio. This example emphasizes the need to successfully monitor ratio changes over the short- and mid-term to catch the more likely extremes as they emerge.