Why The Gold/Silver Ratio Indicates The Beginning Of Long-Term Rally

by Daryl Montgomery, Seeking Alpha:

The Gold/Silver ratio is as high as it was in 2003 and during the Credit Crisis. Both peaks were great buying opportunities for gold and silver . Even if the ratio goes higher, it is still signaling a buy for the two precious metals.

The gold/silver ratio was over 80 again in early April. Recently it peaked at 83.29 in late February. Prior to that high, its peak was 83.73 at the height of the Credit Crisis more than seven years ago. Both gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) were major buys at that point, but silver more so. The metal rallied approximately 450% over the next three years. The gold/silver ratio has varied from around 15 to close to 100 in the last 200 years and extremes today should be considered to be significant buy and sell signals.

Any figures in the gold and silver ratio prior to 1975 are not the same as now because the U.S. government controlled the price of one or both metals prior to that time, skewing the ratio number. The ratio was around 16 for most of the 1800’s because this was believed to be the proportion of silver to gold in the earth’s crust (the U.S. Geological Survey now gives 18.6 as the proper ratio for the continental crust). The ratio only fell to 16 again around 1920, 1967, and 1980. Since both the gold and silver markets were trading freely in 1980, this indicated a multi-decade high for the metals. The ratio bottom in the 2011 gold and silver peak was only in the low 30s, so that high is NOT likely to be a multi-decade one.

The low point of the ratio in the teens is not likely to change because it is based on an unalterable relationship between the amount of gold and silver in the earth. The high point, on the other hand, is subject to various and sundry conditions that can alter it somewhat over time. The high in the ratio might still get to around 100, but it doesn’t have to. This happened in WWII in the 1940s and during the Gulf War in the early 1990s. The first case is not relevant because governments fixed the prices of the metals and wanted silver to be cheap. During the 1990s ratio peak, there was both a recession, which decreased the price for industrial silver, and an international crisis, which increased the price for safe haven gold. The combination of the two pushed the upper boundary toward the 100 level.

Nowadays, the extremes around 15 and 100 should be considered once in every 50 year conditions that indicate very long term tops or bottoms are taking place. Silver actually did hit a major price low in 1993, not very long after the Gulf War peak in the gold/silver ratio. A new range for the gold/silver ratio was established starting shortly thereafter with a top in the low 80s and a bottom in the low 30s. The peaks in 2003 and 2008 proved to be excellent buying opportunities for both gold and silver. The bottom in 2011 was a major sell signal. The chart below shows the current range the ratio is trading in (thin red lines) and the longer-term, once in a half-century limits (thick red lines).

Gold/Silver Ratio Since 1990

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