High-Level Overview: In this article, let's discuss a little something called the Gold to Silver Ratio and how it can help you in your investments into precious metals.
Gold and silver have a long, long history of benefiting mankind's endeavors. Gold was pounded into funeral masks in Egypt and was thought to be the skin of the gods. Silver mined from the South and Central Americas enriched the Spanish Empire so much that it became one of the first true global powers.
Apart from platinum, gold and silver are the two most valuable metals and have been so for thousands of years. Even now, they are considered great sources of investment that offer the investor a haven from the twists and turns of the market. With this, we arrive at the Gold to Silver Ratio, A progression of the prices between the two noble elements that provide an investor the information he or she needs to make smart choices.
But what is the gold to silver ratio exactly? How does it work and how exactly does it help you in your investments in precious metals? All that and more will be answered below.
Related: Gold VS Silver: An Investor’s Guide
What is the Gold to Silver Ratio?
Let's break the topic down into a series of questions. Firstly, what does the gold to silver ratio mean? In simple terms, the ratio is the number of silver ounces it would take to buy an equivalent amount of gold.
That's really it. Nothing too complicated about it per se.
As an example, imagine that an ounce of gold costs $500 per ounce and that silver costs $5 per ounce. The ratio would then be 100:1 (it takes 100 times the cost of an ounce of silver to purchase an ounce of gold). All that seems quite simple enough but what does it have to do with anything?
Well, not much unless you are an avid trader in precious metals. Traders would use the gold to silver ratio to make short and long positions on both metals and make some speculation in the changes in their prices (more on that below).
For now, that's the short and sweet answer to what the Gold to Silver Ratio is.
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How is it Calculated?
Calculating the Gold to Silver ratio is very simple. All you need to do is follow this formula:
Current gold prices/current silver prices = the gold to silver ratio
Let's set an example for this. Imagine that the current price of gold is $1,751.25 per ounce, Silver is only valued at $21.51 per ounce. Since you want to know how many silver ounces are needed to match the price of a single gold ounce, divide the price per ounce of silver by that of gold:
$1,751.25 / $21.51 = 81.40
The result is that the current gold to silver ratio is 81.40:1.
What is the Ideal Ratio? What is the Historical Ratio?
There is no "ideal" ratio in this case. It is purely subjective and depends a great deal on what the intention of the investor is. A low ratio could mean that silver is being favored and that it would be the perfect time to purchase silver cheaply. A higher ratio means an ounce of gold could purchase a lot of ounces of silver -- many investors use this to their advantage in ingenious ways.
There is no fixed ratio and the entire thing is prone to fluctuations almost daily. It is also deeply volatile which makes it not the most ideal basis for speculations on investment. That said, it hinges entirely on the ever-increasing prices of two precious metals. Unless you're extremely reckless with your investments, money put into precious metals rarely doesn't come back larger than before.
Historically, the ratio was set by governments individually. This was to ensure some table backing to each of their currencies. The usual ratio ranges from 12:1 to 15:1. This has been the case for thousands of years because these metals served as the currencies before the fiat money of today. For instance, the Roman empire set the ratio to 12:1. The US government, during the late 1700s, passed a law that set the ratio to 15:1.
This was because the US, like many other nations during that time, followed a Bi-metallic system that their currencies followed. As the decades progressed, the nation slowly began to move away from pegging its currencies to precious metals and, eventually, removed itself from the gold standard completely.
Related: Is Silver a Good Investment in 2021?
What's the Ratio Today?
The current gold to silver ratio plays around the 65:1 to 70:1. Over the last 10 years alone though, the ratio has hit a record high of 124.46:1 and a record low of 36.68:1. Most economists not though that the ratio has been steadily increasing for the past 9 years.
Why is it Important?
Today, the ratio is famous for its frequent fluctuations. Many market analysts and economists argue about what the ideal ratio should be and what to do to stabilize it. That being the case, many investors benefit from these fluctuations and make whole careers out of speculating the ratio of the two metals. Though it should be left to the more experienced class of investors, there is something to be said about the fortunes made based on the ratio.
Many investors also have come to appreciate the way the prices of the two metals only seem to increase no matter what the current economic backdrop might be. They make them suitable sources of investments to hedge against the unpredictability of the market and the inflation of fiat money altogether.
A way that investors use the ratio to grow their wealth is by hedging their bets on either or both metals. For example, you buy silver when the prices are at their historic low and convert them all to gold when the prices hit their historic high. Through this, you increase the overall amount of metal you hold and your assets by extension.
Enthusiasts who engage in this kind of metal-to-metal trading are called gold bugs. They usually look for the quantity value rather than the dollar value simply because it's a given the dollar amount of each ounce of metal is rising anyway.
Imagine that, as an investor, you own an ounce of gold. When the ratio rises to the unprecedented 200:1, you convert this ounce into 200 ounces of silver. When the ratio contracts to 100:1, you then convert your 200 ounces to 2 ounces of gold -- leaving you with more gold than you started with.
For those worried about recessions, market crashes, or just the run-of-the-mill devaluation of investments, speculations on the gold to silver ratio are a wonderful hedge against such events.
Risks of Trading with the Ratio
The main and most prevalent concern when trading metals is making wrong calls in the changes in the ratio. Let's go back to our last example.
Now that you have converted your gold into silvers, capitalizing on the momentary drop in silver prices, you wait for the market to contract to exchange for gold. Sadly, the market never contracts but the price of gold continues to increase. You are, indeed, quite stuck. The only way now that you can have gold again is to buy it back in smaller quantities. This defeats the purpose of increasing your metal assets and, in the long run, leaves you with a loss.
In such a scenario though, the smart thing to do is to continue increasing your gold silver holdings and bide your time when the ratio contracts. Simply exchange for gold then. Of course, there's no way of saying if the ratio will contract ever again -- this is always a present concern.
If speculating in the gold to silver ratio seems too complicated or too dangerous for your liking, there are other alternatives to invest in precious metals that are less dangerous. Whereas trading using the gold to silver ratio requires a full-proof trading strategy, these alternatives require very little of your attention and are quite close to a passive source income one can get.
Gold or silver ETFs (exchange-traded funds) are one such example of alternatives to the gold to silver ratio. In ETFs, all you're doing is buying ownership of a portion of the precious metal the way one would buy a stock of a company. This is a much safer way of investing in noble metals without much need for speculations or hands-on management.
Gold IRA's (such as those offered by Goldco) are another (and recommended) alternative. They allow you to convert funds into physical gold, stored in a vault held by a custodian, and can be done 100% tax & penalty free. You cannot convert existing gold bullion into an IRA, you'd need to sell your gold first in order to convert your funds.
There are also mutual funds that deal exclusively in precious metals. There are readily available in most brokerages and are great sources of short- to medium-term investment. You can also buy stocks from the companies that mine silver and gold. It is an established precedent that these companies post profits even in times of recession because of the value of the metals they mine.
All of the above being said, if you feel like you can keep up with the demands of the gold to silver ratio, and think that you have the energy and drive to be one of those who profit greatly from trading using the ratio, then by all means trade away!