The Gold Silver Ratio

What Is the Gold-to-Silver Ratio, and Does It Matter?
If you’re a precious metals investor, you should understand the importance and limitations of this ratio.

For investors, there are no shortage of investment opportunities to choose from. There are thousands of different stocks, countless mutual funds, and a seemingly endless number of corporate and government bonds to consider investing in. However, one of the more popular investment opportunities since the beginning of 2016 has been precious metals.

The popularity of precious metals grows
According to the World Gold Council, gold demand wound up increasing by 92.9 tons in 2016 to 4,309 tons. Interestingly, a number of key drivers, such as jewelry demand, central bank demand, and technology-based demand, were down year-over-year. However, electronic-traded fund (ETF) inflows reached nearly 532 tons last year, which was the second highest level on record, and is indicative of investors’ growing desire to own a piece of the yellow metal. The more cash that flows into precious-metal ETFs, the more physical metals those ETFs are required to buy.

Similar strength was seen in the silver market, with estimates from the Silver Institute in November calling for record demand for the metal. Much like gold, silver saw a drop off in physical demand for jewelry and industrial purposes, but a pretty rapid rise in ETF-based demand.

Perhaps the biggest (and never-ending) debate among precious-metal investors is what metal, gold or silver, is best suited for your investment portfolio. One of the most commonly turned to ratios to help answer this question is the gold-to-silver ratio.

What is the gold-to-silver ratio?
Put simply, the gold-to-silver ratio describes how many ounces of silver it would take to equal one ounce of gold. In the 1800s, the gold-to-silver ratio was right around 15-to-1, implying that the physical price per ounce for gold was 15 times higher than that of silver. While volatile during the 20th century, the gold-to-silver ratio averaged 47-to-1. As of the Feb. 13, 2017 close for both precious metals ($1,224.70 an ounce for gold and $17.80 an ounce for silver), the gold-to-silver ratio has ballooned to 68.8-to-1.

Some investors use the gold-to-silver ratio to determine which metal looks poised to outperform the other. If the gold-to-silver ratio has fallen below its 20th century average, gold would presumably be the metal investors would want to buy. Conversely, if the gold-to-silver ratio has jumped above its average throughout the 20th century, silver could be the more attractive option.

It’s also worth noting that silver has a tendency to be more volatile than gold because of its lower daily trading volume. In simpler terms, when precious metals are outperforming, silver has a tendency to overshoot its yellow counterpart to the upside. When precious metals are stuck in a bear market trend, silver has a tendency to tarnish much faster than gold.

Does this ratio matter?
Now for the important question: does the gold-to-silver ratio really matter?

To some degree, having such an extensive history on how the prices of gold and silver relate to one another can be useful for investors. Today’s ratio of nearly 69-to-1 would certainly suggest that silver could be the more attractive investment opportunity if (key word here) precious metal prices are heading higher.

However, I think it’s important to recognize that the gold-to-silver ratio isn’t a primary investment factor or a catalyst by itself. It’s a secondary factor to consider long after you’ve examined the real catalysts driving gold and silver prices.

So what really matters?

For starters, it’s important to pay attention to the Federal Reserve’s stance on monetary policy, as well as interest rates. Arguably the biggest driver (both higher and lower) for precious metals is opportunity cost, or the act of passing up a near-guaranteed return in one asset for the opportunity to generate a larger return with another asset. If interest rates remain low, as they’ve been for the better part of eight years, investors who choose to buy interest-bearing assets (such as bonds or CDs) may lose real money to the inflation rate. On the flipside, if interest rates rise, then investors may swap out of precious metals and into interest-bearing assets since they can net a higher guaranteed return, pushing the prices of gold and silver lower.

Supply and demand are also important drivers for precious metals. In recent years, gold and silver mining companies have reduced their capital expenditures and, in the process, tempered supply side growth. At the same time, ETF and investment demand for gold and silver has increased, causing prices for gold and silver to move higher.

Finally, fear and uncertainty are important catalysts that tend to drive investors into gold and silver. The more uncertain growth prospects are in the U.S., and the less confident consumers are with the U.S. economy, the more liable gold and silver prices are to head higher. Remember, the U.S. is a consumption-driven nation, so any weakness in retail sales figures or GDP growth can suggest that gold and/or silver may be a safe-haven investment.

Long story short, feel free to add the gold-to-silver ratio to your arsenal of tools to analyze precious metals and metal-mining companies, but make sure your investment thesis doesn’t primarily revolve around the gold-to-silver ratio.

Silver’s use as an industrial metal can harm its price during economic slowdowns, it’s secondary use as a monetary metal can benefit it’s price during periods of decreasing faith in government. Silver is significantly more abundant than gold in the earth’s crust, this makes it easy to find new supply and silver mines will come on line to drive the price back down if there is a sudden burst of demand. This could provide silver a period of a year or two where it outperforms gold. This can be measured using the gold/silver ratio. When the gold/silver ratio drops below 40, I HIGHLY SUGGEST selling everything related to precious metals, as that number has historically indicated a massive public rush into the metals, which results in the prices reaching a long-term peak in value.

Given the above facts, I feel it is better to own gold in periods of economic weakness and silver in periods of growth. Silver is more appropriate to use as a speculative vehicle, while gold is more appropriate as a means of saving and protecting wealth. If you’ve ever tried selling a few thousand ounces of silver, it’s a hassle! Selling the equivalent value in gold is quite easy. The same argument applies to hiding/storing large amounts of gold and silver.

The current gold/silver ratio is around 72. This means it is definitely appropriate to accumulate silver and silver related investments at this time as a means to speculate in the financial markets. As the number declines (from around 70-50), it indicates the public is becoming interested in the monetary metals. As interest peaks (let’s say, around 30-40), one must be prepared to sell their speculative positions. Gold will decline less than silver when the peak has been reached, suggesting one should cut all speculative positions in silver and gold related assets and potentially hold just a small core position in physical gold.

In summary, gold and silver related investments are both a good buy at this time. Gold will have less volatility due to the large above ground stockpiles. Silver will likely outperform gold at some point, but when it does, you must sell, because the outperformance is a temporary phenomenon and will not continue indefinitely. Both investments have strong fundamentals supporting them. Understanding the underlying drivers for the price of gold and silver helps us to allocate our investments appropriately at different times in the investment cycle. The current gold/silver ratio above 70 indicates a healthy allocation towards silver related investments is appropriate at this point in the cycle.

Gold/Silver Ratio is near an extreme. This ratio demonstrates a lack of investor interest in the monetary metals when the ratio is above 70. It demonstrates a mania to participate in the monetary metals when the ratio is below 35. Each time the gold/silver ratio has gone above 75, it has been an acceptable time to buy silver, gold, or silver and gold stocks. Each time the ratio went below 35, it has been an excellent opportunity to sell precious metals and their related investments.

Thanks for the quality analysis! We sell bullion for physical ownership, and field questions every day with regard to which metal makes the most sense. We tend to lean toward heavier silver currently with the ratio still at 75:1. Interesting point that when the ratio is closest, prices are the highest due to last minute entry of the small investors into the silver market. But we have a long way to go to get there and silver seems to be a relative bargain, even with the gains this week.
If you feel holdings should be trimmed significantly when the ratio drops under 40, presumably because of a spike in price, where would you suggest the small investor put his proceeds? It makes sense that the Dollar would be a poor choice, and stocks may be riskier at that point as well. It seems to me staying put and riding out the storm might be a better choice; at least the metal isn’t going anywhere.

I’m pleased you enjoyed my article. Regarding your question about what to do when the ratio drops below
40, buying the dollar would
Have been a wonderful decision last time. Next time,
I will have to see prices
Of assets around the world to make a decision, ill post a new article at that time.
I realize many gold and silver investors abhor the dollar, however, there are many times when the dollar has been the appropriate place to park cash. I sold a lot of my gold and silver related investments last time the ratio went below 40 and purchased real estate in the Detroit metro area (there had been an approximately 70% crash in the housing
Market). This created a dollar cash flow from rentals. These
Properties have since 2-3x in value while gold and silver have declined significantly.
We’re back at the time
To sell real estate and buy gold and silver. Best regards.