The Long and the Short of Silver and Gold

Brad Zigler

Last November, a novel, if somewhat relativistic, case was made for silver here ("What's Better: Gold or Silver?") Back then, the gold/silver ratio was 55-to-1, a level some observers thought to be a little rich. Simply put, silver was too cheap relative to gold.

Turns out these pundits were right. By early March, gold's multiple had shrunk to 47x when silver's price topped $20 per ounce.

When thinking of the gold silver ratio, the old futures trader in me immediately thinks of a spread: selling gold futures in ratio to purchases of silver contracts. On the New York Mercantile Exchange's COMEX division, special margin rates are afforded for 2-3 ratio spreads. That's two contracts, or 200 ounces, of gold traded against three contracts, or 15,000 ounces, of silver.

Indeed, had you thus sold gold and bought silver at the beginning of the year on an unlevered basis, you would have doubled your money by the first week in March. The ratio has fattened up some in the past month. At a shade under 52-to-1, the year-to-date gain for a cash trade is still a respectable 45%.

Will Silver Outperform Gold Again?

Futures trading, even spread trading, isn't for everyone, though. The alternative strategy for securities account holders would have been selling short shares of a gold grantor trust such as the streetTRACKS Gold Trust (NYSE Arca: GLD) or the iShares COMEX Gold Trust (AMEX: IAU) and buying shares of the iShares Silver Trust (AMEX: SLV).

Shorting, however, requires margin - a deal breaker for otherwise spread-inclined traders.

No bother, though; Deutsche Bank has recently come to market with short and double-short gold exchange-traded notes (AMEX: DGZ and AMEX: DZZ, respectively) that can be purchased for cash to form the short leg of a ratio spread.

The ETNs have had quite a time of it since their February 28 launch, as gold first rose 7%, then cratered to lose 5%. The DGZ note has gained nearly 5.7% to date, while its double-dose sibling is up 13.1% since launch.

Silver, meantime, following a somewhat similar trajectory by rising 8%, then nosing down for a 9% loss, has put SLV 10.4% underwater.

The fact that silver has been beaten up so badly has gotten the silver bugs' contrarian juices flowing again. This time ‘round, though, many would-be spreaders are likely to opt for the long DZZ/SLV combination instead.

Gold/Silver Ratio Legs

Comments

[Nate C:]

I generally like your idea of shorting gold while going long silver. My only concern is with this idea that there is a inherent spread between gold and silver. I know a lot of silver bugs who keep bringing up the idea but is there any historical chart available that shows the spead between gold and silver.

2008 Apr 08 10:50 PM

[misterchan:]

I would have liked more in-depth explanation of DGZ and DZZ, as I have never heard of them before. If anyone can explain them more clearly, I would appreciate it. Will check back.

2008 Apr 09 12:38 AM

[User 149022:]

Nate. The ratio of silver to gold over the last 100 years has ranged from lows of about 15:1 to highs of over 70:1. In general, the spread narrows in a precious metals bull market and widens in a down market.

I think some guys posted a 100 year chart at silverseek.com.

2008 Apr 09 08:17 AM

[Wayne S:]

Nate C -
In 'pre-paper money' times, how long were silver & gold coins in circulation in America? The $20 gold double eagle compared with the $1 silver dollar with about 1 ounce of gold to 1 ounce of silver. A long history of a 20:1 ratio.

2008 Apr 09 09:15 AM

[Managing Ed...:]

Misterchan, DGZ and DZZ are exchange-traded notes (ETNs) issued by Deutsche Bank that track the 1x (DGZ) and 2x (DZZ) the inverse of the Deutsche Bank Liquid Commodity Index – Optimum Yield Gold.

ETNs differ from exchange-traded funds (ETFs) in that they are senior, zero-coupon debt instruments rather than representing a portfolio of futures like the PowerShares DB commodity funds.

As zero-coupon notes, they pay no interest. Issued at $25 pe back in February, their value fluctuates based upon the return of the underlying index. The are tradeable intraday and price-transparent as are ETFs.

At present, there's no tax consequence for holding these ETNs (until liquidation, that is), giving them a decided advantage over gold ETFs like DBG and grantor trusts such as GLD or IAU.

More information can be found at: dbfunds.db.com/notes.

2008 Apr 09 09:22 AM

[Wayne S:]

Nate C -
If you consider the history of American coins, the gold $20 double eagle and the silver dollar coins both had about 1 ounce of metal and carried a 20:1 ratio for a long time.

2008 Apr 09 09:23 AM

[Managing Ed...:]

Nate, the HAI article linked to this story ("What's Better: Gold or Silver?": hardassetsinvestor.com...) contains a table tracking the gold/silver ratio through the 20th and 21st centuries.

If you want finer grain detail of modern-day prices, try the historical statistical archives of the London Bullion Market Association at www.lbma.org.uk.

2008 Apr 09 09:29 AM

[OO1O1OO11O1O:]

Correction: A double eagle contains .96750 oz of gold, which translates to a price of $20.67 per oz of gold. A silver dollar contains .77344 oz of silver, which translates to a price of $1.29 per oz of gold. With a ratio of 20.67 to 1.29, that translates to a ratio of nearly 16:1.

2008 Apr 10 01:39 AM

[Nate C:]

Thanks everyone for the information. Greatly appreciated.

2008 Apr 10 01:58 AM