What is a 'Gold/Silver Ratio'

The gold/silver ratio represents the number of ounces of silver required to purchase one ounce of gold. 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. It also helps investors diversify their precious-metal holdings. 

BREAKING DOWN 'Gold/Silver Ratio'

Today, the gold/silver ratio continually floats as prices shift. However, when currencies were gold- and silver-based holdings, the ratio was fixed. Governments who recognize gold and silver coins as legal tender follow the bimetallic standard as their monetary system. Central banks were in charge of setting or fixing, the gold/silver ratio which provides stability to the currency markets. For example, during the Roman Empire, the gold/silver ratio was fixed at 12/1, or 12 pieces of silver to one gold piece. By the 19th Century, the ratio saw a general setting of 15/1.

As an example, imagine gold is trading at $300 per ounce, and silver is trading at $20 per ounce. The gold/silver ratio would be 15/1, as it would take 15 ounces of silver to buy one ounce of gold. If next week the price of gold falls to $250 an ounce and the price of silver rises to $25 per ounce, the ratio drops to 10/1.

However, the era of the fixed ratio ended in the twentieth century as nations moved away from the bi-metallic standard and, eventually, off the gold standard entirely. With the gold standard, countries agreed to convert paper money into a fixed amount of gold.

Britain stopped using the gold standard in 1931, and the U.S. followed suit in 1933, finally abandoning the remnants of the system in 1971. The gold standard was replaced entirely by fiat money in 1973. Fiat money describes a currency used due to a government order, or fiat, that the currency is acceptable as a means of payment.

Trading the Gold/Silver Ratio Can Be a Wild Ride

In the modern era, the gold/silver ratio can swing wildly. Over the last 100 years, it has shifted even more, from low of 17.73 in April 1919 to a high of 80.61 in January 1980. Traders track the volatile ratio on a minute by minute basis. The ratio can change even if both gold and silver rise or fall in price, so long as they move at different rates.

The ratio swings illustrate the value of gold, silver and other precious metals, such as platinum and palladium, these metals dependence on their relative scarcity as commodities. The metal markets are speculative, unlike stocks or bonds, they do not have a basis on underlying performance measures.

However, unlike other speculative commodity markets such as the oil market, gold and silver are non-consumable. Even when used in such things as jewelry, their value can be recovered. In part, because they don’t go away, precious metals have traditionally been viewed as a haven for investors when other markets are experiencing high rates of volatility.

Hard asset investors can take advantage of the ratio swings by trading the ratio. They will exchange gold for silver when the ratio rises, meaning silver is cheaper than gold. Investors will swap silver for gold when the ratio drops and gold becomes less expensive.

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