The Gold-Silver Ratio ExplainedCOMEX: Micro Gold Futures ( COMEX_MINI:MGC1! ), Micro Silver Futures ( COMEX_MINI:SIL1! )
The Gold-Silver Ratio is a financial term that measures the relative value of gold to silver. Specifically, how many ounces of silver it takes to buy one ounce of gold.
The Gold-Silver Ratio is an important tool for traders and investors. It has been used to indicate the market sentiment towards these two precious metals. A high ratio suggests that gold is more valued than silver, often seen during economic turmoil or when investors seek safe-haven assets. On the contrary, a lower ratio implies that silver is gaining value relative to gold, which normally occurs during periods of economic growth and strong industrial demand.
The ratio fluctuates over time due to supply and demand dynamics, geopolitical events, and changes in the global economy. By analyzing the ratio, traders can make informed decisions about when to buy or sell. This ratio reflects not only the market’s valuation of these metals but also an instrument for profit-making in the commodities market.
Historical Gold to Silver Ratio
Since 2000, the Gold-Silver Ratio has seen considerable fluctuations, reflecting various economic and market conditions. In the first decade of the 21st century, the ratio hovered around 65:1, meaning it took 65 ounces of silver to buy one ounce of gold.
However, the ratio has spiked during times of economic uncertainty. For example, during the financial crisis of 2008, the ratio reached highs not seen in decades. More recently, in the wake of the COVID-19 pandemic and the ensuing economic turmoil, the ratio surged, at one point exceeding 110:1 in 2020, indicating a strong preference for gold as a safe-haven asset compared to silver.
Over time, the Gold-Silver Ratio has been trending up, meaning gold has gained value at a faster pace compared to silver.
As of last Friday, gold is trading around all-time high at $3,330, while silver is quoted at $33.0. This makes the Gold-Silver Ratio almost exactly at 100.
When to Buy and Sell based on the Gold-Silver Ratio?
The decision to buy or sell the ratio hinges on interpreting its current value in the context of historical trends and market conditions.
When to Buy Silver: A high Gold-Silver Ratio, typically at or above the 90:1 mark, suggests that silver is undervalued relative to gold. This is often interpreted as a buying signal for silver. In such scenarios, silver is cheaper than gold, and investors may see it as an opportunity to purchase silver at a relatively low price. The rationale is that if the ratio decreases, the relative value of silver will increase compared to gold, potentially leading to significant gains.
When to Sell Silver/Buy Gold: Conversely, when the Gold-Silver Ratio is low, say around 50:1, it indicates that silver is relatively expensive, or gold is undervalued. In such situations, investors might consider selling silver and buying gold. The expectation is that the ratio will normalize or increase, meaning that gold’s value could rise relative to silver, offering a favorable return on the gold investment.
The Gold-Silver Ratio can be a valuable indicator of when to buy or sell gold and silver. However, since the ratio is not stable but upward trending over time, we could not use a mean-reversion strategy. The price band for normal, high and low ranges should be updated regularly.
Trade Setup with Micro Gold and Silver
Traders could deploy the Gold-Silver Ratio trading strategy using COMEX Micro Gold Futures ( AMEX:MGC ) and Micro Silver Futures ( AMEX:SIL ). The big advantages of using futures contracts are capital efficiency and leverage.
MGC contracts have a notional value of 10 troy ounces of gold. With Friday settlement price of $3,330.7, each June contract (MGCM5) has a notional value of $33,307. Buying or selling one contract requires an initial margin of $1,500 at the time of writing.
By putting a deposit equivalent to less than 0.5 ounce, traders could gain the full exposure to 10 ounces of gold. If gold prices move up by 5%, a long futures position would double in value (= (33307*0.05) / 1500 = 111%). This futures contract has a built-in leverage of 22:1.
Conversely, Micro Silver (SIL) contracts have a notional value of 1,000 troy ounces of silver. With Friday settlement price of $33.02, each June contract (SILM5) has a notional value of $33,020. Buying or selling one contract requires an initial margin of $3,000 at the time of writing.
By putting a deposit equivalent to 91 ounces, traders could gain the full exposure of 1,000 ounces of silver. If silver prices move up by 5%, a long position in Micro Silver futures would gain 55% (= (33020*0.05) / 3000). This futures contract has a built-in leverage of 11:1.
Micro gold futures (MGC, 10 oz) contracts tap into the deep liquidity of standard-size gold futures contracts (GC, 100 oz). As of last Friday, GC has an open interest (OI) of 447,356 contracts, while the OI for MGC is 44,449, according to data from CME Group.
The OI for standard Silver Futures (SI, 5000 oz) and Micro Silver Futures (SIL, 1000 oz) are 154,276 and 12,345, respectively.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
