Different financial instruments do not move in isolation. Instead, markets are interconnected and the prices of various assets are related. This concept is known as “correlation”. When asset prices are correlated, traders can compare the prices of one asset to another and make trading decisions.
Correlation trading is a unique and profitable trading method. Two of the most positively correlated assets are gold and silver. This article answers the question: “What is the gold/silver ratio?” and how to use it in trading.
Both gold and silver are freely tradable commodities against the US dollar. This means that their ratios are free to move as market forces change gold and silver prices.
It wasn’t always like that. In the late 19th and early 20th centuries, the US was on the “gold standard”, which ultimately set the value of gold against the US dollar. For example, in 1944 the US government set the value of gold at $35 per ounce. Setting the price of gold would limit how much the gold/silver ratio moved. The US government officially abandoned the gold standard in 1971.
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The gold/silver ratio is a number that can change as the respective prices of gold and silver change.
- If the price of gold increases by a greater percentage than the price of silver, the ratio will increase.
- If the price of gold falls by a smaller percentage than the price of silver, the ratio will increase.
- If the price of gold rises and the price of silver falls, the ratio increases.
- If the price of gold falls by a greater percentage than the price of silver, the ratio will decrease.
- If the price of gold rises by a smaller percentage than the price of silver, the ratio will decrease.
- If the price of gold falls and the price of silver rises, the ratio will decrease.
At first glance, the gold/silver ratio is affected by changes in the prices of gold and silver.
Manufacturers and other industries use silver in manufacturing. For example, silver is vital in the production of solar cells and electronics. Its physical demand is thus a factor in the global economy. Silver is also bought and sold as a speculative asset.
The value of silver vs gold
The silver market is a small market, about one-tenth the size of the gold market, so it is more volatile— in a smaller market, less trading volume is needed to move the price in either direction. Historically, silver is about twice as volatile as gold.
Thus, the gold/silver ratio is affected by the volatility of silver prices and its demand for use in manufacturing and industry. But that doesn’t tell the whole story.
Gold prices also move and therefore affect the gold/silver ratio. Gold is used much less in industrial production than silver and is traded primarily as a speculative asset. A big reason why investors trade in gold is because they see it as a safe haven asset, i.e. investors turn to gold to preserve value when economic shocks occur, such as during periods of high inflation or stock market declines.
The S&P 500 index and the gold/silver ratio are inversely correlated. When the S&P 500 rises, the gold/silver ratio usually falls, and when the S&P 500 falls, the ratio usually rises.
A good example of inverse correlation was the period of the stock market decline in early 2020. The S&P 500 index fell into bear market territory at a record speed and the gold/silver ratio simultaneously reached an all-time high.
Economic sentiment is a significant driver of the value of the gold/silver ratio. Some traders consider the Ratio to be a leading indicator of economic sentiment. When the ratio is high, economic sentiment is bad and vice versa.
If gold is $1800 per ounce and silver is $24 per ounce, the gold/silver ratio will be 1800/24 = 75.
If the gold/silver ratio is 75, it takes 75 ounces of silver to buy 1 ounce of gold.
Geologists estimate that there is about 17 to 19 times more silver than gold in the Earth’s crust. The production of silver mines worldwide is about 8 times the weight of gold each year.
With silver availability about 17-19 times that of gold and mining about 8 times higher, many people would expect the gold/silver ratio to be at least below 20. However, the ratio has never fallen below 30 throughout the 21st century. Most at the time the ratio was gold/silver between 45 and 85.
The ratio is at an interesting point at the time of publication as it could potentially break above the resistance level at 85.
Before 1900, the gold/silver ratio was around 16, much closer to the physical quantities of every metal on Earth.
Some analysts believe that the gold/silver ratio will eventually return to pre-1900 levels. For this to happen, the price of silver must increase relative to the price of gold, and some analysts cite this as a reason for large investments in silver. However, a falling gold/silver ratio does not necessarily mean that silver prices will rise. The ratio could keep falling even as silver prices fall if gold prices fall much further.
The gold/silver ratio has varied greatly over the centuries that civilizations have used gold and silver as stores of value.
To summarize, the gold/silver ratio is the price of gold divided by the price of silver. For example, if the ratio is 75, it takes 75 ounces of silver to buy 1 ounce of gold.
In the 21st century, the gold/silver ratio fell to 32 in April 2011. The S&P 500 began to recover from the 2008 credit crisis and began the longest US stock market bull run in history. A low value of Ratio 32 in 2011 signaled confidence in the US economy and the stock market.
In the 21st century, the gold/silver ratio rose to an all-time high of 126 in March 2020. That’s when the S&P 500 suddenly began to decline due to market conditions created by covid. The high of 126 in the gold/silver ratio signaled great fear in the US economy and the stock market.
The gold/silver ratio can be changed to a chart such as a candlestick chart. I found that the gold/silver ratio chart defined support and resistance levels and even chart patterns such as triangles. That means I can use technical analysis indicate how the gold/silver ratio might move.
Let’s say I’m bullish on gold and want to take a long trade. To help me time my trade I could examine the gold/silver chart to make sure it looks bullish as well, for example if it recently bounced off a support level. Remember that even if the ratio goes up, the value of gold can still go down. The ratio itself does not mean that gold or silver will go up or down – you should only use it as an additional confirmation.
Before CFDs were popular, if people wanted to trade the gold/silver ratio, they would have to buy or sell both gold and silver in the correct ratio to replicate the ratio. Today, however, traders have access to CFDs that track the value of the ratio – a trader can go long or short the gold/silver ratio using CFDs.
The gold/silver ratio tracks the relative value of gold and silver by dividing the price of gold by the price of silver. A rising ratio means that gold is more expensive compared to silver. A falling ratio means that gold is cheaper compared to silver.
The gold/silver ratio usually moves in the opposite direction to the S&P 500 index. Thus, the ratio is seen as a form of sentiment indicator, especially as investors view gold as a safe-haven asset during troubling economic times.
What is a good ratio between gold and silver?
The ratio has mostly traded between 45 and 85 over the past 25 years.
What happens when the gold-silver ratio is high?
When the ratio of gold to silver is high, Gold is more expensive compared to silver.
What happens when the gold-silver ratio is low?
When the ratio of gold to silver is low, Gold is cheaper compared to silver.
Do gold and silver rise when inflation rises?
Gold appreciates more during inflation because investors see it as a safe-haven asset.
Will gold and silver go up if the stock market crashes?
Both gold and silver usually fall in value when the stock market falls.