How to Profit From the Gold to Silver Ratio

2010-JUL-06

Adam Brochert writes --

Gold and silver have served as stores of wealth for centuries. As with traditional savers storing their paper currencies with banks, many precious metals investors have elected to trust their savings with a trustworthy institution like GoldMoney. Pricing gold or silver in relation to the other can yield interesting and potentially profitable information. The gold to silver ratio, obtained by dividing the price of gold by the price of silver, is a commonly followed metric that creates profitable arbitrage opportunities for astute precious metal investors.

A long term chart of the gold to silver ratio is shown below:

From a nadir of around 17 in early 1980 to a peak of just over 100 in the early 1990s, the above chart gives a glimpse of the wide range for this ratio over the past three decades. However, the ratio has generally held closer to 15:1 over the past several centuries and the current gold to silver ratio is far from its “natural” historical level. Though both gold and silver are monetary metals, they have slightly different attributes, which helps to explain some of the more recent volatility in their price ratio.

Though gold has many industrial applications, the amount of gold consumed is small relative to overall demand. It is monetary demand that primarily drives the gold price, as much of the gold ever mined (about 160 tons) is still stored as wealth in some shape or form. Silver, on the other hand, is often demanded for industrial applications that consume it in addition to being purchased for its monetary qualities. A discussion of gold “reserves” makes sense, while only a small portion of the silver mined throughout history is still available for investment purposes.

The gold to silver ratio thus reflects a combination of the overall monetary demand for precious metals and the industrial demand for silver. Because available silver is scarcer than gold and cheap relative to gold by historical standards, it is likely that silver will outperform gold as the secular bull market in precious metals continues. Demand for monetary metals is starting to outstrip available supply, particularly in silver due to a lack of above-ground silver reserves. Given its economically sensitive side, however, it is likely that silver will continue to be more volatile than gold.

Savers interested in profiting from swings in the gold to silver ratio have two easy and safe methods to do so. The best way to profit from a long-term bull market for the typical investor is to “volume average” into that market by buying on a regular basis. When it comes time to buy physical precious metal, whether one takes possession or stores precious metals securely with GoldMoney, one can choose to buy gold or silver depending on whether the gold to silver ratio is high or low. Additionally, it is easy and inexpensive for GoldMoney customers to exchange silver for gold or vice versa. These simple maneuvers can increase one’s profits without significantly increasing risk.