The gold-silver ratio has soared recently, attracting investors’ attention. In this article, ZFX will introduce what the gold-silver ratio is and the historical trend of the ratio. We will also explain the significance of high/low ratios and their importance to investors.
What is the Gold Silver Ratio?
The Gold-Silver Ratio is the price ratio of one ounce of Gold to one ounce of Silver, or how much Silver can be bought for the same amount of Gold.
In general, gold and silver are classified as precious metals, so most of the time their trends are consistent. At some point, however, fundamental factors will cause the two to rise and fall in different degrees, resulting in different gold silver ratios. As a result, the ratio fluctuates constantly.
So what are the factors that cause different fluctuations in gold and silver?
Figure 1: Historical price movements of gold and silver
Gold: Used as jewelry and for investments
First, we need to know the uses and needs of gold and silver. Since ancient times, gold has been a symbol of nobility and power, so its biggest use is still as jewelry and investment. In electronics, manufacturing, and industry, gold is used less because it is expensive.
Figure 2: Distribution of gold supply by use
Silver: More used in the industrial field
Silver, on the other hand, plays an important role in industrial demand. It is widely used in the industrial field because of its excellent electrical conductivity among the precious metal family. It also means silver is more vulnerable to economic cycles than gold.
Figure 3: Distribution of Silver supply by use
Historical Trend of the Gold Silver Ratio
Figure 4: Historical level of the gold-silver ratio
Based on past data, the reasonable gold-silver ratio is around 60, with a peak around 80, meaning that the ratio tends to fall when they are around 80.
Note that a rise in the gold-silver ratio does not necessarily mean a rise in the gold price or a fall in the silver price, but rather a difference between the two. Even if gold and silver both fall, but gold decline less, the gold-silver ratio may still rise. Conversely, if the ratio falls, gold may not rise as much as silver.
What does it mean if the Gold Silver Ratio is high or low?
As explained above, the gold-silver ratio is similar to the exchange rate between currencies. Because of their different characteristics, gold and silver often rise or fall apart. Let’s consider a few factors:
Is gold a safe haven?
When will gold become more expensive? Gold has traditionally been seen as a safe haven, and its surge has often been a harbinger of financial crises. Moreover, countries around the world also tend to print money to boost their economies, so when the economic environment is bad, gold tends to keep its value and soar against the trend.
Is silver dominated by industrial demand?
In terms of silver usage, it is still dominated by industrial demand. That makes silver behave much like a risky asset such as stocks. If economic conditions are bad, for example, manufacturing and industrial activities fall sharply, the demand for silver will fall and the price will drop. Silver price also has drivers beyond economics. Traditional photography, for example, used to use silver as a catalyst. However, with the development of digital photography technology and the decline of the traditional photography industry, the demand for silver has naturally decreased.
Figure 5: Silver versus S&P futures index
As the above figure shows, the silver price is roughly in line with the S&P futures index, supporting the conclusion that it is vulnerable to economic cycles. We can say that the silver, as a market indicator, is similar to copper, iron and other metals that are wildly used in the industry. However, silver still has some hedging function, so the silver price tends to be driven by the gold price. If the gold price rises or rises sharply, the silver prices will also rise, which may not be of reference in terms of economic indicators.
Why have the Gold Silver Ratios Soared Recently?
Figure 6: Points in time when gold-silver ratio rose
As can be seen in the above chart, the gold-silver ratio spikes in June 2007 and early 2020, respectively, during the financial crisis and the COVID-19 outbreak. This reflects the fact that the gold-silver ratio tends to soar when systemic risks arise in the broader environment.
The main reason is that when there is a crisis in the financial market and a big problem in the real economy, silver’s industrial demand may be sharply affected, dragging down the price of silver. However, gold can either rise or fall less rapidly on the back of safe-haven demand. So the gold-silver ratio tends to go higher than during these times.
In early 2020, the global COVID-19 outbreak caused a sharp decline in economic activity, causing a sharp drop in silver prices and a sharp rise in the ratio. Silver, however, has since followed gold’s safe-haven rally and even outpaced gold as a global rescue effort boosted economic demand. This explains why the ratio will rise and fall sharply in 2020.
Gold Silver Ratio Trading Strategies
A ratio of 60-80 is considered to be a reasonable range in terms of past fluctuations.
Once the ratio exceeds 80, there is strong hedging demand in the market and it is an indicator of the market direction. Some traders will take advantage of the ratio to assist their trades.
In addition, once the ratio rises sharply, there is the possibility of a downward correction, which reflects the gold price has risen too much and is prone to a correction, or the risk aversion fades and silver prices rebound. More aggressive traders can short gold and long silver when the gold-silver ratio rises above 80, even when the gold price is stronger. (Please note that this is a hedging strategy and must be performed when the gold and silver contracts have the same value). As long as the ratio falls, traders can profit.
Of course, there are more detailed reasons for the fluctuations of the gold-silver ratio, such as the size of the market value of gold and silver, and the level of speculation, which will not be discussed here.
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.