Futures Commentary: GSR

Gold/Silver Ratio

March 25^th, 2011

Historical Extreme?

Precious metals traders have been watching the ratio between gold and silver for years, measuring how many ounces of silver it takes to buy one ounce of gold. Over the past couple of decades this ratio has been particularly volatile, reaching nearly 100:1 in the early 1990s, and now at a multi-decade low of around 39:1. There’s no mystery regarding how this ratio has come down to such a depressed level (though we will be examining whether or not this is actually a depressed level), as silver’s rise has been outpacing that of gold significantly, especially over the past year. Over the past 12 months, silver has risen over 121 percent, while gold has risen only 30 percent. The last time we saw the Gold/Silver Ratio (GSR) at this level was back in the early 1980s, when the Hunt brothers attempted to corner the silver market sending prices skyrocketing, albeit very briefly, and then once again a few years later.

Going off of recent memory alone, the current GSR would appear to be overextended on the downside, but what if we look back even further? Below is a chart of the GSR going back to 1950, when the prices of the precious metals were essentially flat. I have also included a chart of the actual prices for the two going back to the same time-period.

Gold/Silver Ratio

Courtesy of Bloomberg

Gold and Silver

Courtesy of Bloomberg

As the charts show, the GSR has now returned to approximate level where it remained steadily for decades before the precious metals were freely traded.

Looking back even further, much, much, further, we see that during the middle-ages the GSR was steady at around 16:1. Interestingly enough, this ratio is seen elsewhere in the precious metals market; in 2009, the last reliable data available, total mine production of silver was approximately 16 times that of gold. Taking a longer term view of this relationship, it begs the question of whether the GSR is really at an extreme level, or if it is merely returning to a long-term historical norm.

One thing is for sure, this has been a volatile relationship ever since the 1970s. Below is a regression showing the monthly prices going back to 1980. The asterisk at the top right-hand corner denotes the current level.

Regression