Platinum and Gold
Source: Scott Wright, Zeal Research (7/30/10)
"How much of a relationship do these metals really have?"
Platinum and gold are definitely on the same playing field in that they are both commodities in the midst of powerful secular bull markets undergirded by strong long-term fundamentals. Platinum's bull gathered momentum around the same time as gold's, in 2001, and had seen a 448% gain to its 2008 high.
Categorically these metals have a lot in common in that they are both very precious. In fact, measured by price platinum is more precious than gold. With it getting as high as $2273 in March 2008, and currently at about the $1500 level, it definitely costs more to buy an ounce. And with platinum's annual production volume at about 6.0 Moz., about 8% that of gold's, it is more rare.
Also like gold, platinum has many different applications. Auto catalysts and jewelry are by far the largest demand components. But there are a whole slew of other uses, from turbine blades to medical sensors. Platinum even has an investment side to it via a growing market for coins, bars, and the new asset-backed ETFs.
But from a trading perspective, do platinum traders really tune in to the actions of the bellwether precious metal? The following charts will paint pictures of how these two metals really do relate. And as you'll find, there are indeed very compelling technical relationships.
In this first chart is platinum and gold's secular picture, and the similarities sure are visually striking. As you can see, these metals had a very tight correlation prior to the infamous stock panic of 2008. When gold rallied, platinum was right there with it. And when gold pulled back, platinum followed suit. Not only is this correlation visually apparent, but the math concurs. From 2002 to August 2008 platinum had an amazing correlation r-square of 95% with gold!
This means 95% of the daily behavior of platinum's price could be explained by the daily movement of gold. An incredibly tight correlation! Despite platinum's own fundamental merits, this long-term correlation shows gold to be a very strong technical driver of platinum. But thanks to the stock panic, this correlation came to a screeching halt.
In those wretched late-2008 months when every asset was being sold off with reckless abandon, platinum set a course for ruin and was oblivious to what was happening with gold. During the panic the only correlation was the fact that both metals were down. On a day-to-day basis, an r-square of 22% showed these metals were dancing to different tunes.
From their all-time highs in the beginning of the year, platinum and gold plummeted 66% and 29% respectively to their 2008 panic lows. Platinum was simply obliterated, falling to prices not seen since 2003. But these outsized losses compared to gold were not a complete surprise considering the nature of platinum's market.
Since platinum trades in such a tiny market compared to most other commodities, it doesn't take much outsized buying or selling pressure to quickly move its price. And this allows sentiment to play a much larger role. With such an incredible state of fear during the panic, traders aggressively unwound their platinum positions, thus resulting in a high-velocity decline.
Finally after traders realized the world wasn't coming to an end in late 2008, platinum found its panic bottom and quickly entered into recovery mode. And it would have its work cut out for it to recover from such catastrophic losses. Gold of course found its bottom around this same time, and platinum would look back to the yellow metal to set its course. From the panic bottom to current, these two metals have sported a correlation r-square of 85%.
But as is glaringly obvious in the chart above, gold has easily recovered its panic losses and platinum has not. In September 2009 gold achieved a new all-time record high, and has been trending higher ever since. Platinum has had an excellent recovery of its own, more than doubling so far off its panic lows. But it is nowhere near its highs from a couple years ago.
Platinum bulls are, of course, very concerned that this metal has not retested its highs while gold has blown through its own. But I believe this is easily explainable when you consider the utility of these metals. And it is simple economics that tells the precious metals story that has played out in recent years.
With continued supply strain on the mining fronts for both platinum and gold, it is the activities on the demand side of the economic scale that have of course been the big price drivers. And as anyone with a pulse is fully aware, the current global recession has radically altered the demand for virtually all goods and services.
During recessionary times it is especially likely for demand to fade in such areas as industrials. When consumption and development slows, manufacturers produce fewer goods. And these same manufacturers tend to drain their inventories during such times, lowering demand even farther. So naturally those metals with higher industrial exposure are more likely to experience economic strain. And this strain typically results in decelerating demand growth and/or falling prices.
Gold has minimal industrial exposure, an average of only about 10% of its demand in recent years, with investment and jewelry by far the largest demand components. So with minimal economic pressure on the industrial side, a structural supply deficit and growing mainstream exposure on the investment front, this metal easily warrants the price activity seen thus far.
When you consider platinum's sensitivity to the economy, this metal doesn't feel quite as precious. Over the last 5 years an average of 66% of platinum's annual usage has come from the industrial side of things. And with the largest industrial-type demand coming from the automotive industry, this recession has no doubt strained platinum. Much lower global vehicle production has led to 2009 autocatalyst demand being nearly half what it was in 2007 according to Johnson Matthey (JM).
This weak industrial demand put the platinum market into a surplus in 2009. And if it wasn't for huge jewelry demand out of China (2.0 Moz.), 2009's surplus would have been much larger than the 285k ounces JM estimated. So did platinum's price warrant a reversion to its highs like gold? Absolutely not!
But just because platinum's interim fundamentals are struggling along with the economy, it doesn't mean its post-panic gains to date are a fluke and that long-term fundamentals have been compromised. According to numbers provided by JM, since 1999 platinum has run a 2.1 Moz. supply deficit, even after the 2009 surplus. Platinum is also in the midst of a running, 3-year production decline on the mining front.
If investment (helped by the emergence of asset-backed ETFs) and jewelry (China is just starting to get a taste for this metal) demand continues to strengthen while the economy continues its turnaround, platinum will quickly revert to a deficit environment. And this will of course send prices much higher.
So where can we expect platinum prices to go once its interim fundamentals stop holding it back? Let's again look to gold for some guidance. And in the platinum/gold ratio we see a technical relationship that goes beyond correlation. The PGR divides platinum's daily closing price by gold's daily closing price. And the resulting data charted over time reveals a fascinating picture.
The PGR line in blue does a fine job expressing platinum's relationship with gold in a single data series, showing where platinum tends to trade relative to gold over time. When the PGR is rising, platinum is either outperforming gold or declining at a slower pace. And when the PGR is falling, gold is either outperforming platinum or declining at a slower pace. The resulting number is how many ounces of gold it takes to be equal in value to one ounce of platinum at any point in time.
As you can see in this chart, up until the panic platinum had a well-defined secular relationship with gold. For 6 years the PGR resided within a horizontal trading range, from about 1.75x on the low side to 2.10x on the high side. When platinum traders got excited the PGR would approach the high side of this range, on two occurrences vaulting the PGR well above resistance. And when traders showed fear the PGR would slide towards support, with 1.75x holding very strong. Over this 6-year span the PGR averaged 1.95x. This means that during the lion's share of platinum's bull leading up to the panic, it would cost two ounces of gold to buy one ounce of platinum.
Towards the end of these 6 years of normalcy, in the first half of 2008, the precious metals would see huge rallies, and platinum traders really got excited. In this tiny market it doesn't take much differential buying pressure to bid this metal up real fast. And with a PGR above 2.30x, platinum was well outperforming gold.
But right away in the second half of 2008 platinum followed the entire commodities complex into a much-needed correction. And just as easily as platinum outperformed gold on the upside, as you can see by the PGR's sharp decline platinum's losses outpaced gold's on the downside. And with the panic accelerating this correction, buyers of platinum became difficult to find.
By early September the PGR had decisively knifed through support, and continued to plunge until it bottomed at 0.97 in December. With platinum's loss at over twice that of gold's (-66% versus -29%), it is easy to see how the PGR could be sliced in half. But even though this metal had more of a fundamental reason to fall harder than gold, it was radically oversold. And at this bottom traders could hardly believe platinum was trading at par with gold!
A PGR at or below 1.00 would have seemed simply unheard of just a few months before it actually happened. Platinum trading at or under the price of gold has been an extremely rare occurrence in recent decades. In fact, the last time it actually happened was 12 years prior, in late 1996. And this was only for a very brief spell. Platinum had not decisively been below gold for nearly 25 years. Over these last 25 years less than 2% of trading days had seen platinum lower than gold, each instance only marginally.
This super-low PGR of 0.97 had not been seen since January 1992, showing just how ridiculously oversold platinum was. But it didn't take long for traders to recognize this anomaly, and going into 2009 platinum mounted a powerful rally. To its high in April platinum gained 128%, well outpacing gold's 58% gain over this period. And as you can see, this outsized gain has led to an uptrending PGR over the last year and a half or so.
But even with the PGR heading in the right direction, it still has a long way to go before it gets back to its pre-panic secular trading range. Just to get to the 6-year average platinum would need to climb to about $2300 at today's gold price, which would be a new all-time high. And of course if gold rises from today's levels, platinum's price would need to be even higher in order to return to a 1.95x PGR.
So what does this still-low PGR, well under 1.50x, tell us about platinum's future? Well if the PGR returns to normalcy, platinum must continue to outperform gold on balance. And I do believe this is possible considering platinum's speculative nature, which historically shows this metal having positive leverage to gold when traders get excited.
But in order for this to happen platinum needs fundamental support. And based on what we know about the state of the platinum market, this support may not be too far away. The fundamentals are currently falling back in line, and it won't take much of a demand boost for this metal's balance to revert back to a deficit.
If this happens the PGR should continue to be a reliable tool even in this post-panic environment. In isolation the PGR means nothing, but we can't discount 6 years' worth of such a telling relationship between platinum and gold. Over such a long span a lot of random noise is filtered out, which makes it more likely that this relationship actually has underlying fundamental support.
Now does this mean the PGR deserves to be in that pre-panic range today? Probably not. It will take time for platinum to recover from this recession. But you know what, more and more cars will be built, platinum jewelry demand still has a lot of upside—and investment in this precious metal is just getting rolling. The PGR's return to normalcy won't take much time once platinum traders get excited again.
And platinum traders won't be the only ones profiting from this metal's resurgence. The miners pulling this metal from the ground are in line for huge profits as its price continues to rise. In our acclaimed weekly and monthly newsletters we recently recommended an elite platinum stock that will greatly benefit as the PGR continues its grind upwards. Subscribe today to get this pick and other high-potential commodities-stocks picks that are well positioned to leverage the ongoing commodities bulls.
The bottom line is platinum and gold have a relationship that goes beyond the preciousness of these metals. And while platinum will ultimately live and die by its own fundamental merits, what happens in the gold markets has shown to color this metal's sentiment, and thus price. Gold is the bellwether precious metal, so it will naturally have an influence on its peer group.
This influence on the upside usually leads to platinum outperforming gold. And this is exactly what's played out since the panic bottom. But as the PGR reveals, platinum still has a lot of catching up to do if it is to return to its pre-panic secular trading range. If the PGR continues to trend higher, which it should based on platinum's bullish secular outlook, much higher platinum prices are in store.
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