Trading the Gold-Silver Ratio

Effectively, the gold-silver ratio represents the number of ounces of silver it takes to buy a single ounce of gold.

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.

Here’s how investors and traders can benefit from observed changes in the gold-silver ratio.

What Is the Gold-Silver Ratio?

The gold-silver ratio, also known as the mint ratio, refers to the relative value of an ounce of silver to an equal weight of gold. Put simply, it is the quantity of silver in ounces needed to buy a single ounce of gold. Traders can use it to diversify the amount of precious metals that they hold in their portfolio.

Here’s how it works. If gold trades at $500 per ounce and silver at $5, traders refer to a gold-silver ratio of 100:1. Similarly, if the price of gold is $1,000 per ounce and silver is trading at $20, the ratio is 50:1. Today, the ratio floats and can swing wildly.

That’s because gold and silver are valued daily by market forces, but this has not always been the case. The ratio has been set at different times in history and in different places by governments seeking monetary stability.

Gold-Silver Ratio History

The gold-silver ratio has fluctuated in modern times and never remains the same. That’s mainly due to the fact that the prices of these precious metals experience wild swings on a regular, daily basis. But before the 20th century, governments set the ratio as part of their monetary stability policies.

For hundreds of years prior to that time, the ratio was often set by governments for purposes of monetary stability and was fairly steady, ranging from 12:1 to 15:1. The Roman Empire officially set the ratio at 12:1. The U.S. government fixed the ratio at 15:1 with the Coinage Act of 1792.

During the 19th century, the United States was one of many countries that adopted a bimetallic standard monetary system, where the value of a country’s monetary unit was established by the mint ratio. But the era of the fixed ratio ended in the 20th century as nations moved away from the bimetallic currency standard and, eventually, off the gold standard entirely. Since then, the prices of gold and silver have traded independently of one another in the free market.

Here’s a quick overview of the history of this ratio:

• 2022: From 2021 to 2022, the ratio fluctuated greatly, ranging from around 65 to 95.
• 2020: For the year, the gold-silver ratio peaked at 114.77, the highest it has been since 1915.
• 1991: When silver hit record lows, the ratio peaked at nearly 100.
• 1980: At the time of the last great surge in gold and silver, the ratio stood at about 15.
• 1834–1862: Congress moved to change the ratio to 16 from 15.
• 1792–1834: The U.S. operated a bimetallic standard, with a fixed ratio of 15.
  
• Roman Empire: The ratio was set at 12:1.

Why Does the Gold-Silver Ratio Matter to Investors?

Despite not having a fixed ratio, the gold-silver ratio is still a popular tool for precious metals traders. They can, and still do, use it to hedge their bets in both metals—taking a long position in one while keeping a short position in the other metal. When the ratio is higher and investors believe it will drop along with the price of gold compared to silver, they may decide to buy silver and take a short position in the same amount of gold.

Why is this ratio so important for investors and traders? If they can anticipate where the ratio is going to move, investors can make a profit even if the price of the two metals falls or rises.

Trading 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:

1. 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.
2. When the ratio then contracted to an opposite historical extreme of 50, for example, the trader would then sell their 100 ounces of silver for two ounces of gold.
3. 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 values of the metals is considered important rather than their intrinsic values.

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.

Ways to Use the Gold-Silver Ratio to Trade

There are a number of ways to execute a gold-silver ratio trading strategy, each of which has its own risks and rewards.

Futures Investing

This involves either the simple purchase of either gold or silver futures contracts or buying one to sell the other if you think the ratio will widen or narrow. The main advantage (and the disadvantage) of this strategy is the same: leverage. That is, futures trading requires only a relatively small amount of cash upfront to place a much larger trade. This can be a risky proposition for those who are uninitiated. An investor can play futures on margin, but that margin can also bankrupt the investor.

Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETFs) offer an accessible and simple means of trading the gold-silver ratio. Again, the purchase of the appropriate ETF—gold or silver—at trading turns can be used to execute your strategy. Some investors prefer not to commit to an all-or-nothing gold-silver trade, keeping open positions in both ETFs and adding to them proportionally. As the ratio rises, they buy silver. As it falls, they buy gold. This keeps the investor from having to speculate on whether extreme ratio levels have actually been reached.

Options Strategies

Options strategies in gold and silver are also available for investors, many of which involve a sort of spreading. For example, you can purchase puts on gold and calls on silver when the ratio is high, and the opposite when the ratio is low. The bet is that the spread will diminish with time in the high-ratio climate and increase in the low-ratio climate. A similar strategy can be applied to futures contracts. Options, however, permit the investor to put up less cash and still enjoy the benefits of leverage with limited risk.

Options have a time decay component that will erode any real gains made on the trade as time passes and the options contracts approach expiration. Therefore, it could be best to use long-dated options or LEAPS to offset this risk.

Pooled Accounts

Commodity pools are large, private holdings of metals that are sold in a variety of denominations to investors. The same strategies employed in ETF investing can be applied here. The advantage of pool accounts is that the actual metal can be attained whenever the investor desires. This is not the case with metal ETFs, where very large minimums must be held to take physical delivery.

Gold and Silver Bullion and Coins

It is not recommended that this trade be executed with physical gold for a number of reasons. These range from liquidity and convenience to security. Just don’t do it. You can buy and hold physical gold and silver for long-term investment purposes, but it is very difficult and expensive to trade in and out of these metals in this way.

The Bottom Line

There’s an entire world of investing permutations available to the gold-silver ratio trader. What’s most important is that the investor knows their own trading personality and risk profile. For the hard-asset investor concerned with the ongoing value of their nation’s fiat currency, the gold-silver ratio trade offers the security of knowing, at the very least, that they always possess the metal.