Using the Gold/Silver Ratio to Measure Sentiment
The gold/silver ratio is a reading of just what it implies: the ratio of the price of one ounce of gold to the price of one ounce of silver. Put another way, this ratio indicates how many ounces of silver it would take to buy an ounce of gold. While both metal prices are affected by inflation and supply and demand, gold is sensitive to market uncertainty in a way that silver is not. That's why looking at this ratio—to determine how investors are valuing the two metals, relatively—can be a barometer for overall investor sentiment.
When people have a cautious market outlook, they often buy gold as a way to hedge their investments. Historically, gold has served as a store of value, and it has been used as a medium of exchange for millennia. The gold/silver ratio helps remove the effects of inflation, supply, and demand (which tend to affect gold and silver the same) to narrow in on the effects of market uncertainty, which does not affect silver as much as it does gold.
Focusing on the ratio, rather than spot prices only, tells traders whether fear or optimism is in control of market sentiment. That makes it a critical signal in times of economic and political upheaval.
Like the Cboe Volatility Index® (VIX) indicator, the gold/silver ratio is often used to measure market uncertainty. The two measures work differently, though, so it's important traders understand the difference.
Using measures of sentiment
Traders use sentiment measures to help gauge the effect of emotions in the market. This not only helps them evaluate risk, but it also helps them identify whether their own emotions are valid. A trader may be sensing unease in the market, but is it really there? Using a sentiment indicator can help.
In combination with other factors, a trader can refer to these sentiment indicators to help determine when it's time to make a move by either hedging, opening, or closing a position. Some traders also use sentiment factors as a contrarian measure, looking to find bargains that fearful traders are ignoring (or, conversely, identify potentially overbought vehicles that are ripe for a pullback).
Calculating the gold/silver ratio
The gold/silver ratio is simply the price of one troy ounce of gold divided by the price of one troy ounce of silver. To see this on the thinkorswim® platform, navigate to Charts, then Studies. Search for PriceRatio, select Lower, and then enter /GC (gold futures, continuous expiration) for symbol1 and /SI (silver futures, continuous expiration) for symbol2 on the Inputs menu.
Source: thinkorswim platform
The chart below shows the S&P 500® index (SPX) on the top pane and the gold/silver ratio on the bottom pane. Notice that the gold/silver ratio spikes as the SPX becomes more volatile.
Source: thinkorswim platform
Comparing the gold/silver ratio to the VIX
The VIX is a measure of market volatility based on the implied volatility in current options contracts. Sometimes known as the fear index, the VIX measures how much volatility traders are expecting when they enter options transactions.
The chart below shows the SPX on the top pane and the VIX on the bottom pane. The VIX tends to rise when the SPX falls and stay flat when the SPX rises.
Source: thinkorswim platform
While the VIX and the gold/silver ratio both measure sentiment, they behave differently. In the period shown below, the VIX is prone to short-lived, dramatic movements, while the gold/silver ratio tends to stay elevated after an initial spike.
Source: thinkorswim platform
Bottom line
Because gold tends to attract buyers in times of uncertainty, the gold/silver ratio has become notable as one of many sentiment indicators in an active trader's tool kit. It's a broader measure than some market indicators, such as the VIX, which tend to reflect spikes in financial uncertainty rather than longer-term unease. But all sentiment indicators can help traders separate their own emotions from the emotions currently affecting the markets. When the gold/silver ratio is low, it's generally safe to assume there's not much worry priced into the market.
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