Silver and its ratio to gold

Marius Paun | London, UK | Senior dealer | Wednesday, 6th November 2019

If someone would be interested in gauging how cheap or expensive the price of silver is right now, probably the simplest method is to look at gold to silver ratio. The ratio measures how many ounces of silver it takes to buy an ounce of gold. If it is 100 it means gold is 100 times the price of silver. As such if the ratio is high then silver is rather cheap on a relative basis and possibly a trade to sell gold and buy silver could be considered. If the ratio is low, then gold might be considered cheap and the opposite trade might make sense.

Why is the gold to silver ratio important and closely followed? Simply put because of history. Both metals have been in use for thousands of years, so they really stood the test of time, giving us plenty of data to consider their relative value.

As it happens, geologists seem to agree that there is around 15-17 times more silver in the Earth’s crust than gold which means gold is therefore 15-17 times rarer.

So theoretically, the so-called natural ratio between the two is around that level and to mirror that, gold should be 15-17 times the price of silver. And history provides us with some clues. In ancient times, when both metals were used as currency, the ratio between them was fixed officially by royal decree.

For example, in Greece, the ratio stood at 13 ounces of silver to gold and in Rome the fix was 12 to one. In the USA which had a bi-metallic standard until 1875, the ratio stood at 15. Nevertheless, moving into the 20th century, gold and silver both have been abandoned as currency and we saw that ratio moving a lot higher. In April 2011 when silver reached $50 an ounce, the ratio went to 30 but that low mark by recent standards was rare and short-lived during the last century.

Today it stands at around 85. By historical standards, the ratio is now extremely high.

For all its potential as a great investment, its qualities of being both an industrial metal and a precious metal, the truth is that since it has lost its monetary status silver has never delivered. One day probably it will go back but hey ‘markets can stay irrational (from that point of view) longer that one would stay solvent’ goes the saying so caution should also be applied. So for those who think reversing to the mean might one day happen, the ancient ratio and /or the natural ratio of 15-17 is a good reference point.

One significant use for the gold to silver ratio is the credit markets. When the ratio is rising i.e gold is outperforming silver, it can be a possible indication of credit stress associated with tightening. In that case, silver drops quicker than gold. Conversely, when the ratio is falling and so silver is the outperformer it is likely that we are in an inflationary period with credit actually expanding. That’s because of silver’s industrial metal qualities and the fact that it tends to outpace gold on the way up.

Physical silver has always remained a reliable store of value, despite no longer being a medium of exchange. A similar story applies to gold. As we mentioned before silver is cheap on a relative basis and is more practical for every day small purchases. CPM Group, the commodity research company, points out that silver inventories have collapsed, dropping over 70% since the 1960s. They also add that most the governments no longer hold stockpiles of silver and officially only US, India and Mexico warehouse silver.

Global silver supply has peaked at around 1000 million ounces in 2014-2015. By and large silver is a by-product from gold, copper and zinc operations. So with commodities entering a downturn, miners were forced to cut costs. As a result, exploration and development of new silver mines were reduced dramatically.

At the same time, demand is growing. Believe it or not, silver is used in almost every major industry due to its conductivity: electronics, medical applications, renewables. The demand is split between industrial uses (about 55%), jewellery (35%) and investments in the form of coins and bars (10%). China may be slowing down due to its trade dispute with the US but the total silver demand in China has increased over 5 times since 2000!!! So, fundamentals for silver are rather encouraging.
Let’s look at the technicals…

The long-term trend is clearly down. However, silver has been moving sideways for the past 6 years, largely within $14.00 – $22.00 range.

On a 10-year chart, silver touched a low of $12.4 in July 2009. It then rose incredibly fast reaching a high of $49.78 in April 2011. Since then it collapsed almost as fast, retesting the lows within the next 24 months or so.

We can see the short-term moving averages (9 MA) crossed above the longer-term ones (21 MA) and both beginnings to point upwards now. So, the short term is bullish with a low of $13.9 touched in November 2018. But the medium-term trend is sideways so that tends to make the moving averages less reliable. They fare better in trending markets.

On the way down, support just below $17.00 mark is the next target for the bears. It will be followed by $15.70 and $14.00 which has been retested unsuccessfully a few times in 2015 as well as November last year.

On the way up, bulls will look to break above $18.50 which acted as good resistance numerous times going back to 2009. It could be followed by $19.50 but ultimately a breach above $21.10, the high of July 2016 will shift the medium-term trend to bullish. That also matches the 23.6 Fibonacci retracements.