Sunday, February 28, 2016

Gold To Silver Ratio - Be Careful With That Indicator

Despite the big move up printed by gold, silver and precious metals stocks, one of the basic measures watched by precious metals analysts i.e. the gold / silver ratio (the number of ounces of silver it takes to buy one ounce of gold), is currently at one of its highest readings in history:

As the chart shows, today this ratio stands at 83.27. In modern history such high readings were printed only in 2003 and in late 2008. In the long-term, the absolute high was seen in 1991.

Usually such a reading is regarded as an indication of a revearsal (the end of a bear market) . However I would be cautious about this thesis. Let me show how this ratio was working in the past.

Period 2001 - 2006

As the chart shows, a BUY signal for silver was generated in the middle of 2003. However, both gold and silver (and precious metals stocks) were in their bull markets since 2001. The extreme reading printed in 2003 was a good signal to exchange long positions in gold for long positions in silver but both metals continued their up leg after 2003 (until 2008).

Period 2007 - 2010

This time the high reading of the Gold / Silver ratio was a good indicator of the end of a short but huge correction in the precious metals bull run (March 2008 - November 2008). Taking long position in silver (especially in this metal), gold and precious metals stocks, according to the Gold / Silver ratio, was a very good idea.

Period 1990 - 1991

In February 1991 the ratio of Gold / Silver printed its absolute high - above 102. However, both metals continued their bear markets after February 1991. Despite its extremity, the high ratio was not an indication of a trend reversal.

Summing up

I would be very cautious when analysing the Gold / Silver ratio. As the charts above show, sometimes it was a good indication of a trend reversal but more often this ratio was just a confirmation of the  ongoing trends (upward or downward).

On the other hand, the high reading of this ratio was always a good indication to take long positions in silver, instead of long positions in gold (or a combination of a long position in silver and short position in gold).

The current high reading tells that it is better idea to have long position in silver than in gold but the final absolute return does not necessarily have to be positive.

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