Gold/Silver Ratio
Research for Online Investors

by John Dalt

5/13/11

Unless you live under a rock, like in the Geico commercial, you know the silver market has been in turmoil for the last two weeks.  You many have heard about the Gold – Silver Ratio. Volatility in precious metals is high enough to cut into an experienced trader’s bankroll.  A little discussion on an old term and its implications may be timely.

In the Coinage Act of 1792, congress established the U.S. Mint, preserving the right of all persons to have coinage struck with their gold or silver at ‘established ratios.’  Alexander Hamilton, as the Treasury Secretary, established the ratio at 15 to 1.

This ratio was roughly the same that had been used in Europe since the late 1500’s  This ratio was the perceived value of each metal in relation to the other.  Large amounts of silver were discovered in Spain, Mexico and Peru.  The ratio established the exchange rate for miners to change their silver in currency or gold.

Some parts of the world valued silver at a much higher rate.  In Asia, Africa and India silver was valued at a higher rate with a ratio that generally stayed below 10 to 1.  By the late 1800’s silver had lost much of its attraction for currency.  Governments preferred to keep reserves in gold.  After the U.S. (under Nixon) took away the backing of gold and silver for the dollar and made coins out of other metals, governments dumped over three billion ounces of silver and 150 million ounces of gold on the market.

With that history, the following chart shows the gold/silver ratio for the last 36 years.

You can see the dip in 1980, when the Hunt brothers drove the price of silver to $50 per ounce.  Over the next 11 years the ratio climbed until peaking at 100 to 1 in 1991.  Since then, the market seems to have established a “normal” range of around 60 to 1.  The chart below shows the last three years with a horizontal line drawn at 60 to 1.

The recent price of gold and silver hit lows in October 2008.  Since then, gold has led the metals higher with silver closing some of the valuation gap through 2009 and the first eight months of 2010.  Here is a chart of gold over the past three years.  I have included a blue line for the 200-day moving average.

In August, silver grabbed trader’s attention as protection from inflation.  Here is silver with the same 200 day average line.

The fall in silver over the last two weeks has brought the price down to $34.66  The 200 day average is $28.76 which appears to have provided strong support over the last two years.  With the five margin increases imposed by COMEX in the last two weeks, we believe silver contracts held by leveraged traders have been forced into the market.  When the dust settles, the remaining players will be stronger.  At that point, silver may be poised for another run higher.

Many traders try to use a gold/silver ratio to justify a trade of one metal against the other in a pair trade.  For example, if the ratio is below 50 they would go long gold and short silver, believing the ratio will come back into ‘balance.’  Today we have looked at the history of this ratio.  Caution shoud be taken when considering recent ratios, as they may not be trustworthy or tradable.

Quote:
It’s not tyranny we desire; it’s a just, limited federal government.---Alexander Hamilton

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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