The Gold Silver Ratio

Gold & Silver have been a store of wealth for more than 6000 years. They’re traded separately, yet they’re fundamentally tied together through history; through the rise and fall of empires, dynasties and nation states.

What is the Gold Silver Ratio?

The simplest explanation of what the gold silver ratio is can be answered with a single question. How many ounces of silver does it take to purchase an ounce of gold? If the ratio was 1 then the answer is that 1 ounce of silver will buy 1 ounce of gold. This however has never been the case.

Historical estimates are that throughout history 190,000 metric tonnes of gold and 1.6 million tonnes of silver have been mined. This is a ratio of 12 tonnes of silver for every 1 tonne of gold. However through history when gold and silver were used as official money the ratio was approximately 16:1.

In the United States in 1792 the official rate was fixed by law at 15:1. What this meant was that 15 ounces of silver could be traded for 1 ounce of gold.

Today as both gold and silver are traded openly on world markets the ratio actually changes daily. This is based on the idea that a free market will determine a fair price. This also means that the prices of gold and silver and as such the ratio itself are subject to the ebbs and flows of market sentiment.

In March 2020 the ratio hit an historic high of 125:1. As of August 2020 the ratio has come back down to approximately 72:1. Silver itself has been historically undervalued against the price of gold. It has often been described as the poor mans gold as it is cheaper to purchase.

How can we use the ratio?

As both of these metals fluctuate on price in the open market the ratio is often used by investors as an indicator of when to purchase each metal. Since the decoupling of the US dollar from gold in August of 1971 the price of gold has been free-floating against world currencies. However the price of gold is still measured primarily in US dollars per troy ounce. When President Nixon suspended the convertibility of the US dollar for gold the price was $35 per ounce and had been since 1933. It immediately increased in price not because the value went up but because the US dollar lost value against it.

Since that time the price of gold has fluctuated hitting highs of US$850 per ounce in January 1980 and then going back down to approximately US$282 per ounce in at the beginning of 2000. The price of both metals fluctuates daily as they are traded and each is subjected to the sentiments of the market. However one simple strategy that is often used is to trade the ratio.

What this means is that when the ratio is higher than a particular threshold silver is the metal to buy. When the ratio drops below a lower threshold then gold becomes the metal of choice. This is not a recommendation of how to invest as this should be done in consultation with a qualified financial planner. However this is a method that has been used by various investors.

Trading the ratio refers to buying silver when the ratio is high and then selling that silver and purchasing gold when the ratio is low. Then as the ratio once again goes high selling the gold and buying silver. In theory, over time doing this consistently will enable the accumulation of increasing amounts of the metal.

Stores of Wealth

Gold and silver have been stores of wealth as well as being used as money for more than 6000 years. Although today it is rare for them to be used as money, they are still highly sought after as a form of wealth insurance.

It should be understood that the only way to make money off physical gold and silver is to sell the metal. So modern investors rarely see it as an investment asset. However there are a variety of reasons why owning physical gold and silver is seen as a wise move by many people.

Firstly it is a physical item that we can hold in our hand. This can create a sense of real ownership for us as individuals instead of owning a stock or another form non-material asset.

Having physical possession or access to the metal removes what is referred to as counter party risk. This refers to the possibility that someone involved in transaction will default on their obligations. This type of risk exists within credit, investment and trading transactions. Think about it like a stock, when we own a stock in a public company the only control we have is whether to hold or sell the stock. We can’t control the actions of the Board, the management or the behaviour of the employees. All of these as well as many others can have an impact on the value of the stock.

Even in our own bank accounts, we are an unsecured creditor to the bank. What this means is that if the bank fails then we can lose our money.

In the modern economy as currencies are not backed by anything except a promise by the issuing government, precious metals offer an insurance policy against a variety of threats.

The gold silver ratio has proven to be an effective method of measuring and trading the value of these two popular metals against each other in order to accumulate greater levels of wealth.

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