Trade idea: gold vs. silver

Shaun Murison, IG senior market analyst, examines an opportunity to trade the close correlation between silver and gold. This is one example of a pairs trading strategy.

While gold and silver share a lot of similarities – not least their status as safe haven assets – there are important differences between the two. Gold, for one thing, has much fewer industrial uses than silver, which can make silver a better bet when economic growth is strong.

The gold/silver ratio is a well-followed measure for investors, showing the number of ounces of silver you could buy with a single ounce of gold. When the ratio reaches 80, it is seen by some as a signal that silver is oversold.

One way of trading the gold/silver ratio is via a pairs trade. A pairs trade is a market-neutral strategy that mutes the impact of broader market movements. It does this by matching two correlated assets – just like gold and silver – and taking a long position in one and a short in the second.

It can also be applied to a pair of exchange-traded funds, currencies, stocks or options.

Pairs trade example

Say that silver has risen past 80 on the gold-silver ratio. A pairs trader would go long on silver, the weaker of the pair, while shorting gold. They would then close their position when the pair’s relationship had normalised.

Any profit comes through the price change between the two metals. The win-win would be for the long position to rise and the short to slip, but it is possible to profit in many market scenarios, whether it rises, falls, drifts or is volatile.  If the long rises more than the short, or the short falls more than the long, the trade will still be in profit. 

IGA, may distribute information/research produced by its respective foreign affiliates within the IG Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, IGA accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact IGA at 6390 5118 for matters arising from, or in connection with the information distributed.

This information/research prepared by IGA or IGA Group is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update.

See important Research Disclaimer.