HardAssetsInvestor

Written by Julian Murdoch  |

October 26, 2009

How To Play The Gold/Silver Ratio

Details

We take a fresh look at the magic number and discuss how investors can use it to their advantage.

• Silver's strong—but is gold in a bubble?
• Could we ever see 30:1 again?
• How to use ETFs to play the ratio

Whether you're a gold bug or a silver buff, you've been a happy camper so far in 2009. As of Friday's close, gold was at $1,056.40, up 20 percent year-to-date. Silver has done even better; it was up 56 percent to settle at $17.723.

The upward trend has many investors going long in both metals, but there's more you can do with gold and silver than just buy and hold. You can also play the two metals off one another—but to do it successfully, you must first understand the ever-changing gold/silver ratio.

The gold/silver ratio tells you the number of ounces of silver it would take to purchase one ounce of gold at a specified date. If you examine gold and silver prices reaching back 100 years or more, the historical ratio most commonly quoted is 30:1, where 30 ounces of silver would buy you one ounce of gold.

But if you change the time period, that average changes. In the last 12 years, for example, the ratio has held closer to 60:1, meaning that it takes lots more silver to buy one ounce of gold. And in just the past three years, the ratio has fluctuated from 45 to 85, driven by the volatility in the prices of the metals themselves.

As of Friday's close, the gold/silver ratio was sitting slightly below 60, at 59.72:

Of course, looking at the ratio in a vacuum tells you nothing—it's just a number, after all. It's only after you factor in the dimension of time and the price movements underlying the number that you can make sense of the gold/silver relationship.

What's Driving The Ratio Down?

The gold/silver ratio will drop if either: a) gold decreases more than silver does, or b) silver increases more than gold does.

This latter case is what we've seen so far in 2009. Since the beginning of the year, both metals have had great returns, but silver has outperformed gold, increasing 56 percent year-to-date while gold only increased 20 percent: