What Is the Gold-to-Silver Ratio, and Does It Matter?
For investors, there are no shortage of investment opportunities to choose from. There are thousands of different stocks, countless mutual funds, and a seemingly endless number of corporate and government bonds to consider investing in. However, one of the more popular investment opportunities since the beginning of 2016 has been precious metals.
The popularity of precious metals grows
According to the World Gold Council, gold demand wound up increasing by 92.9 tons in 2016 to 4,309 tons. Interestingly, a number of key drivers, such as jewelry demand, central bank demand, and technology-based demand, were down year-over-year. However, electronic-traded fund (ETF) inflows reached nearly 532 tons last year, which was the second highest level on record, and is indicative of investors' growing desire to own a piece of the yellow metal. The more cash that flows into precious-metal ETFs, the more physical metals those ETFs are required to buy.
Image source: Getty Images.
Similar strength was seen in the silver market, with estimates from the Silver Institute in November calling for record demand for the metal. Much like gold, silver saw a drop off in physical demand for jewelry and industrial purposes, but a pretty rapid rise in ETF-based demand.
Perhaps the biggest (and never-ending) debate among precious-metal investors is what metal, gold or silver, is best suited for your investment portfolio. One of the most commonly turned to ratios to help answer this question is the gold-to-silver ratio.
What is the gold-to-silver ratio?
Put simply, the gold-to-silver ratio describes how many ounces of silver it would take to equal one ounce of gold. In the 1800s, the gold-to-silver ratio was right around 15-to-1, implying that the physical price per ounce for gold was 15 times higher than that of silver. While volatile during the 20th century, the gold-to-silver ratio averaged 47-to-1. As of the Feb. 13, 2017 close for both precious metals ($1,224.70 an ounce for gold and $17.80 an ounce for silver), the gold-to-silver ratio has ballooned to 68.8-to-1.
Some investors use the gold-to-silver ratio to determine which metal looks poised to outperform the other. If the gold-to-silver ratio has fallen below its 20th century average, gold would presumably be the metal investors would want to buy. Conversely, if the gold-to-silver ratio has jumped above its average throughout the 20th century, silver could be the more attractive option.
Image source: Getty Images.
It's also worth noting that silver has a tendency to be more volatile than gold because of its lower daily trading volume. In simpler terms, when precious metals are outperforming, silver has a tendency to overshoot its yellow counterpart to the upside. When precious metals are stuck in a bear market trend, silver has a tendency to tarnish much faster than gold.
Does this ratio matter?
Now for the important question: does the gold-to-silver ratio really matter?
To some degree, having such an extensive history on how the prices of gold and silver relate to one another can be useful for investors. Today's ratio of nearly 69-to-1 would certainly suggest that silver could be the more attractive investment opportunity if (key word here) precious metal prices are heading higher.
However, I think it's important to recognize that the gold-to-silver ratio isn't a primary investment factor or a catalyst by itself. It's a secondary factor to consider long after you've examined the real catalysts driving gold and silver prices.
So what really matters?
For starters, it's important to pay attention to the Federal Reserve's stance on monetary policy, as well as interest rates. Arguably the biggest driver (both higher and lower) for precious metals is opportunity cost, or the act of passing up a near-guaranteed return in one asset for the opportunity to generate a larger return with another asset. If interest rates remain low, as they've been for the better part of eight years, investors who choose to buy interest-bearing assets (such as bonds or CDs) may lose real money to the inflation rate. On the flipside, if interest rates rise, then investors may swap out of precious metals and into interest-bearing assets since they can net a higher guaranteed return, pushing the prices of gold and silver lower.
Image source: Getty Images.
Supply and demand are also important drivers for precious metals. In recent years, gold and silver mining companies have reduced their capital expenditures and, in the process, tempered supply side growth. At the same time, ETF and investment demand for gold and silver has increased, causing prices for gold and silver to move higher.
Finally, fear and uncertainty are important catalysts that tend to drive investors into gold and silver. The more uncertain growth prospects are in the U.S., and the less confident consumers are with the U.S. economy, the more liable gold and silver prices are to head higher. Remember, the U.S. is a consumption-driven nation, so any weakness in retail sales figures or GDP growth can suggest that gold and/or silver may be a safe-haven investment.
Long story short, feel free to add the gold-to-silver ratio to your arsenal of tools to analyze precious metals and metal-mining companies, but make sure your investment thesis doesn't primarily revolve around the gold-to-silver ratio.
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