How To Play The Plunging Gold/Silver Ratio

April 12, 2011

Find out why the gold/silver ratio is at 28-year lows and how you can position yourself for its next move.

 

At a time when commodities across the board have surged to multiyear, even record, highs, it's hard for any one individual commodity to stand out. Oil's spiking, sending retail gasoline prices spiraling toward $4; floods in Australia have lifted coal prices to new heights; corn's hovering near record highs; and cotton is in the stratosphere. Let's not forget about gold, which, week after week, has steadily climbed to new all-time highs.

Yet somehow, one commodity that isn't even at a record high yet has managed to steal the spotlight. I'm talking, of course, about silver.

Now granted, silver may not be the most crucial commodity out there. Relative to crude oil, silver's impact on the economy is inconsequential. And when it comes to safe-haven investing, the metal is dwarfed by its far-more-prominent cousin, gold. But when it comes to the one metric that counts most to investors — performance — silver has the rest beat.

Year-to-date, the white metal is up a whopping 30 percent, well ahead of the pack. It's bested only by cotton's 40 percent return.

What's most pertinent for precious metals investors is the significant divergence between silver and gold. While, yes, gold is clearly in an uptrend, striking a fresh record this week, its recent performance pales in comparison to that of silver. Since the beginning of the year, the yellow metal is up a mere 2 percent.

But gold's underperformance (and silver's outperformance) actually started well before now; in fact, you can see signs of it as early as the middle of last year.

 

Reading The Gold/Silver Ratio

The clearest way to visualize this is using the gold/silver ratio. For those who aren't familiar with it, the ratio literally measures the relative value of gold and silver; in other words, how many troy ounces of silver it takes to buy one troy ounce of gold.

The ratio itself is a snapshot of a moment in time, but if we look at movements in the ratio, we can see the relative performance of the two precious metals. An increase represents either gold outperformance or silver underperformance (or both), while a decrease represents silver outperformance, gold underperformance or both.

 

Gold/Silver Ratio: 2006 - 2011

Source: Bloomberg

 

Since about June of last year, it's been straight downhill for the ratio, which fell from close to 65 then to 35 now. That's an enormous decline—historic even. In fact, at 35, the ratio is at the lowest level since 1983—28 years ago.

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