Thursday, July 22, 2010

An Interesting Pairs Trade

Gene Chan's rationale is both simple and straightforward. He suggests shorting GLD and buying SLV, making for a pairs trade that'll work out if the gold-silver ratio narrows.
[C]onsider that a geological analysis of the Earth's crust shows that silver is only 17.5 times more abundant than gold. In fact, over the last 4500 years of history the average price ratio between silver and gold is pretty close to that number. Back in the days when metals are still money, you could exchange 1 gold coin for 16 silver coins.
What this means is that gold is severely overvalued versus silver, and the gap will revert over time, regardless of whether precious metals as a group rise or fall.
He considers gold to have a fat speculative premium built in, which silver doesn't. Plus, anyone expecting economic Armageddon would find silver easier to use for ordinary transactions than gold.

There's a more conservative means to playing it this way: simply buying physical silver, perhaps along with physcial gold. The most cost-effective way fo doing so is through "junk silver" coins.


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