The Difference between Gold and Silver

Asad Dossani
Here is a graph of the gold to silver price ratio in dollars over the last twenty years, courtesy of goldprice.org.

Gold to Silver price ratio
Source: goldprice.org

The gold to silver price ratio is simply the price of gold divided by the price of silver. When this ratio is high, gold is relatively expensive as compared with silver, and vice versa.

When I first started trading commodities, I was fascinated by this ratio. Why do gold and silver move around so much relative to one another? When is the ratio lower or higher, and why? What is the fundamental link between these two commodities? My interest in this topic remains as strong as ever; and now I'll share some of what I've learned about this ratio.

Over the long run, we should expect this ratio to be stable. Why is that? Well, gold and silver are substitutes for one another. Not perfect substitutes, but substitutes nonetheless. Particularly when it comes to investing, gold and silver often move together, and tend to represent safe haven demand.

But from this chart, we can learn about some of the key differences between gold and silver. And if you are buying one of these assets to protect your portfolio, this is going to be important.

First note that this ratio does not stay above 80 for very long. So when the price ratio is close to that level, we can expect silver to outperform gold. Right now, we are above 70, indicating that gold is a little overpriced.

But take a look at what this ratio does in different market conditions. In the early 2000s, during the dot come bubble burst, this ratio goes higher. During the financial crisis in 2008, this ratio skyrockets. And in the last couple of years, gold has once again outperformed silver.

Silver tends to do well when market conditions are good. Whenever this ratio drops, it is usually during times of market increases. The exception has been the most recent data, where silver has been falling alongside most other commodities.

What can we learn from this? Second, gold is a better safe haven asset than silver. So if you are truly interested in portfolio protection, then gold is the way to go. Silver on the other hand provides less protection, but is more likely to hold its value when markets go up.

The reason for this is that silver is also an industrial metal. Demand for silver is driven in part by industrial needs, and this is positively correlated to the overall market.

Second, gold can protect you during a market crash, but can hurt you afterwards. When the gold price ratio reaches high levels, particularly following a crash, the ratio then falls dramatically afterwards.

This is one of the major drawbacks of gold. Even if it protects you during a crash, it hurts you once markets recover.

Third, you can make money trading the gold silver ratio. Keep in mind that this ratio is stable over the long term only. We can't make money doing this as a short term strategy. Based on the chart, a good strategy would be to buy this ratio when it is below 50, and sell it when it is above 70. Note that buying this ratio means taking a long position in gold and a short position in silver.

This type of trade is known as a pairs trade. A pairs trading strategy takes a long position in one asset and a simultaneous short position in another asset. It makes or loses money depending on the ratio between the prices of the two assets. In this case, we are examining gold and silver. But this strategy can be applied to any two assets that are fundamentally related to one another.

Are you interested in the gold to silver price ratio? Share your views in the Club or share your comments here.

P.S. I'd like to share additional trading strategies with you. And one of my best ones you can find at Alpha Trader.

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6 Responses to "The Difference between Gold and Silver"
DR.V.R.MEHTA
31 Aug, 2017
A VERY GOOD ARTICLE, EXPLAINED NEATLYLike 
Rd
06 Nov, 2014
New to all this . Shall I buy silver at CMP. Or shall I start sip from now till ratio reaches above 80 . Please advise. Like 
hoshang dehnugara
29 Oct, 2014
a good study and guidanceLike 
Thilakanandan.C
28 Oct, 2014
Another advantage of gold is we can pledge it and create more wealth out of it. Silver doesn't have this advantage.No banks would give us silver loan they offer only gold loans. Thank you.Like 
Manoj Tewary
28 Oct, 2014
Explained so lucidly that it appears to be obvious. The end result is a simple actionable idea. Great & Thanks for the education.Like 
Sanjeev
28 Oct, 2014
Thanks, Asad. I learnt some new things today.Like 
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