Gold:Silver Price Ratio Narrowing

Monday February 16, 2009, 9:39pm PDT

The silver price has rallied over the last four weeks as the reality of a worsening recession begins to sink in for investors.  Although silver is outperforming gold in the precious metals market-rising four times as fast as gold -it is currently trading at a lower absolute price per ounce than 30 years ago, according to Arabianmoney.coms Peter J. Cooper .

Silvers price rally is not surprising given the current financial climate; Though what is more important, note many analysts, is the movement in the gold:silver price ratio, which has dropped nearly 7 points in the last month.

During the heyday of the Roman Empire, the gold: silver price ratio hovered around 1:15, or one ounce of gold for 15 ounces of silver. And in the early years of the U.S. for a time that ratio was fixed by law.  Throughout the 20th century, however, the average ratio was 1:47 and in the last decade has averaged 1:60.

As Cooper pointed out, the gold:silver ratio always tends to narrow in a financial crisis. For example, during the 1960-1961 and 1980-82 recessions the ratio tightened to about 1:38.  One reason for this, says Cooper, is that silver stocks are less than a hundredth the size of gold stocks and so there is the simple play of supply and demand on the price relative to the supply and demand of gold.

We started 2009 at 1:78 and as of today the ratio has decreased to sit just below 1:70, nearly twice that of the 1980s recession.

Traders have been paying close attention to the price ratio recently and using it as a guide. Technically-driven trading of the ratio has also been important, said Rhona OConnell in a recent Mineweb article. Once the ratio had severed support at 72 this trading gained considerable traction and within two days we were at 69, en route for a test of 67, the lowest since late September, when gold was at $740 and silver at just less than $11, added OConnell.

It is not the price ratio itself, per se, that drives the market, acknowledges OConnell, but once in a while it does come into play.  Interestingly, it usually has more of an impact on the price of silver than on gold. She points out that over this latest period, the price of silver has increased by 21 per cent as compared to 13 per cent for gold.

OConnell offers up sentiment and perception as the driving forces behind this latest round of price gains. Because of its dual designation as precious and industrial metal, the silver market is highly volatile. And yet, this bane can also prove boon. Savvy investors are known to utilize silver exposure as a way of increasing their exposure to gold. As The Motley Fools Christopher Barker has advised, silver offers far more upside potential. for [those] seeking precious metals exposure. Not on its own, of course, but as the perfect complement to gold exposure.

If gold is performing strongly, most seasoned investors know silver will follow suit; hence, investment in both is clearly an advantage over investment in gold alone. And it is this knowledge and action, most analysts agree, that is strongly affecting the current upward movement in the silver price.

Barker predicts the gap between gold and silvers valuation will continue to narrow as the current recession continues, reaching as low as 1:20. That would mean silver at $45 today at present gold prices, he said. However, he believes that the gold price could climb as high as $1,650/oz before the 1:20 ratio is reached, putting silver at $82/oz.

Of course, Barkers forecast would be viewed by some as pure fantasy. However, its not too outlandish to believe that silvers price performance will continue to impress those in the precious metals market as long as the fundamentals for gold remain strong.