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Many investors are becoming increasingly optimistic about the U.S. auto industry. But if one is positive on the outlook for the automakers, it can be argued that they should be even more enthusiastic about the prospects for platinum and palladium going forward.

A variety of sound reasons support a constructive view on the domestic car business. First, total auto sales continue to climb off of the financial crisis lows in early 2009 that at the time ranked among the lowest levels since the early 1980s. Sales have returned to just above the historical average over the last four decades and appear to have further room to run, given that the current number of sales relative to the U.S. population remains relatively low. The fact that the average age of current vehicles on the road is also roughly 11 years suggests the potential for an increase in replacement demand going forward. Drawing from my own personal situation, one of the cars I drive just reached 10 years of age, and I will need to replace it sometime over the next 12 to 18 months whether I want to or not. Lastly, if the U.S. economy continues to sluggishly improve, auto demand is likely to continue to rise along with it.

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A strong fundamental case can also be made for owning both major U.S. auto makers in General Motors (GM) and Ford Motor (F). Both companies continue to increase operational efficiency and improve their businesses in the years since the financial crisis. And both trade at attractive valuations, with GM at 6 times and Ford at 8 times forward earnings. In the interest of full disclosure, I have been long Ford over the last few years for the reasons mentioned above and more.

But if one is positive on the outlook for GM and Ford, perhaps the upside potential for both platinum (PPLT) and palladium (PALL) should appeal even more. Although both are widely known as precious metals, the primary application for both is in the actual catalyst in catalytic converters found in automobiles. Overall, nearly one half of all platinum and nearly 60% of all palladium are used in automobile production. Thus, the price direction of both precious metals is closely tied to the car industry.

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Since the beginning of 2012, the share prices of GM and Ford as well as the prices of platinum and palladium moved largely in lockstep until the end of last year. And while they started to diverge in early 2013, they showed signs of reconverging on a few occasions during the first quarter. But since the start of Q2, the prices of GM and Ford stock have soared at the same time that prices of platinum and palladium have plunged. This has created what is now a wide divergence and something has to give going forward. Either the surge in the share prices of General Motors and Ford are justified and the prices of platinum and palladium will catch up due to increased demand, or the move higher in GM and Ford shares was misguided and these prices will fall back to the path of the precious metals. This pair trade implies a more favorable risk reward profile for owning platinum and palladium over the automakers at this juncture.

Several other characteristics favor owning platinum and palladium above the automakers. First, it is not just General Motors and Ford that use these precious metals in automobile production. By owning platinum and palladium, it effectively provides more direct exposure to the potential for automobile demand growth globally, including key emerging markets. Also, while a large percentage is used in automobile production, these are still precious metals that also serve (to a degree) as a store of value against global currency debasement and potential crisis. Thus, these metals are somewhat less sensitive to the global economic cycle and have some countercyclical and uncorrelated characteristics by their nature, which has appeal from a diversification standpoint.

For these reasons, an allocation to platinum and palladium may have particular appeal. It should be noted that both metals have been caught up in the downside pressure that has been overhanging the precious metals complex including both gold (GLD) and silver (SLV) for the last several months, which helps explain the divergence in the price of platinum and palladium relative to the automakers. Thus, more short-term volatility should be expected in the near-term. But for those with a medium-term to long-term view, both metals may offer particular appeal at the present time. For those seeking to establish exposure to platinum and palladium, the Sprott Physical Platinum & Palladium Trust (SPPP) is a suitable choice.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Source: If You Like The Automakers, You Should Love These Metals