Gold and silver ratio a longer term opportunity
The gold and silver ratio has moved out of sync, which could be setting up a longer term opportunity for traders.
A standard deviation channel has been drawn over the gold / silver ratio. The centre line of this channel highlights the mean of the relationship, while the upper and lower levels of this channel highlight two standard deviations above and two standard deviations below this mean.
Circled red we see that the ratio has moved above the two standard deviation level. This highlights the fact that the price of gold has been outperforming (in terms of price action) that of silver. The historic relationship between these two metals would suggest that extreme outperformance of gold against silver at present is irregular. This provides the suggestion and expectation that this relationship may revert to a historical mean (the centre line).
A reversion of this relationship back towards the mean (should it occur) could happen in one of three ways:
The price of gold falls while the price of silver rises
The price of gold rises while the price of silver rises at a faster rate
The price of gold falls at a faster rate than the price of silver falls
Rather than taking a directional view on each of these commodities, traders might consider trading the relationship of these two metals instead i.e. a pair trade. This would be done by taking a short trade position on gold, against an equally sized long trade position on silver. Should one of the three scenarios presented above occur, the pair trade would be profitable.
It should be noted that this view is presented as a long-term view on the gold /silver ratio and could take months to develop if the assumptions are correct. A move in the ratio back to the mean would equate to a 35% profit target for the pair trade. Traders of this move might consider using a stop loss threshold roughly half the size of the anticipated reward (17.5%).
This information has been prepared by IG, a trading name of IG Markets Ltd and IG Markets South Africa Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. 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. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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