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Gold Silver Ratio

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 A strategy among traders globally is to exploit the gold-silver ratio these days -be it on US-based Comex or on local bourse MCX, where the contract tracks that on the former. The gold-silver ratio basically denotes the amount of silver it takes to purchase a unit of gold.

1. What's the strategy?

To buy silver and sell gold. On Comex since both prices are in ounces you can buy one or more contract of silver and sell one (or more) of gold.

2. Why do traders use it?

The average ra tio of the front month gold and silver contracts over the past year is 75.35 meaning its takes 75.35 ozs of silver to buy one oz of gold. However, since March 23, the ra tio has jumped to over 80 (on Friday it was 80.85). Essentially trad ers sell the ratio. When it narrows they make money and if it rises they lose. So, it's better to trade with a stop loss.

3. Can you explain it further?

It means selling one oz of gold and buying one oz of silver.

You make money in event of both commodities rising or falling -but the price of the one that's purchased must rise more than or fall less than that of the one sold so the ratio declines. Assume one commodity trades at $100 an oz and the other at $200. The ratio is 2. You buy the first sell the second. If $100 becomes $98 and $200 becomes $195, you make a net gain of $3 as the ratio slips to 1.98.Similarly, if $100 becomes $105 and $200 becomes $202, you make a net profit of $3 as the ratio slips to 1.92. But if $100 becomes $98 and $200 becomes $205, you lose $7 as the ratio rises to 2.1.So it's very important to trade with a stop loss.

4. When do you buy the ratio?

If it's below the historic mean.

For example, if the average one year ratio is 75.35 and if the current ratio is 74, you can buy gold and sell silver -that is buy the spread.

5. Can one do the same on MCX?

Yes. One gold contract on MCX is 1 kilo while one silver contract is 30 kilos -it means you'll have to buy three contracts of silver for one of gold, in the current case, because of the odd quotient (79.43 kilos). But you also have mini gold and silver contracts.Motilal Oswal Commodities is recommending buying six silver minis and selling four gold minis.

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