Lately a lot of interest is being generated towards commodities as the equity market is being faced by massive selling pressures.
In the precious metal space, Gold has traditionally been viewed as a "safe haven" by investors, especially at times when currency markets and shares are experiencing high rates of volatility. Silver on the other hand has considerably more industrial uses, so its demand depends on the health of the global economy.
An interesting consideration to make when trading gold and silver is to look at the Gold/Silver ratio (GSR).
What is the GSR?
It was around 3,000 BC that the first Egyptian Pharaoh Menes declared that two and one-half parts silver equal one-part gold. This was the first recorded comment of the relationship between gold and silver and since then the ratio has continued to evolve.
The gold/silver ratio represents the number of ounces of silver required to purchase one ounce of gold. The Gold Silver Ratio (GSR) simply refers to the extent that the price of Gold is higher than the price of Silver, or the relative price of Gold to Silver.
The comparison is very easy, as both precious metals are measured in ounces: if the price of Gold is $1200 and the price of Silver is $12, the GSR stands at 100.
To calculate GSR, simply divide the current gold price by the current silver price.
Using the ratio in trading
Although gold and silver trade more or less in sync, there are periods when the ratio drops or rises to levels that could be considered statistically "extreme." These "extreme" levels create trading opportunities.
Investors use the fluctuating ratio to ascertain the relative value of silver compared to gold. This comparison allows the trader to determine the optimal time to purchase one metal over the other.
When the Gold/Silver Ratio rises, it means that gold has become more expensive compared to silver, and the cheaper metal might offer better value. When the ratio falls, it means gold has become less costly relative to silver.
Gold or Silver - which one to choose?
Historically, a spike in the gold/silver ratio above the 80.00 level has tended to bode well for the silver price in the near term (At the moment ratio is at 84). Once the metals find a bottoming out point and have a reason to rally (weak USD), silver normally goes on to outperform gold in such cases.
As we can see from the below chart, most of the time the Gold/Silver ratio is above 80, Silver would then outperform Gold during the period. Conditions change as soon as the ratio falls below 50.
Today it takes about 84 ounces of silver to buy a single ounce of gold. That looks like an opportunity. If history could serve as a guide, now would be a good time for metals investors to favour silver over gold.