Why Gold Buyers Should Consider Platinum

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 |  Includes: AAUKY, AQPTY, GLD, LNMIY, PPLT
by: Avery Goodman

Today, as this article was being written, something unusual happened. The equities markets are partially weaned from the ever increasing flow of the waterfall of newly printed funny-money from the Fed, Bank of England, ECB and Bank of Japan, and stock prices are falling fast. This is a natural and normal process that is to be expected. Even with the dramatic price drop of the last few weeks, world equities markets are still heavily inflated over their fair value. The world economic environment is bad and there is every prospect that it will stay bad, or even get worse over the next five to 10 years. Concepts that investors once took for granted, such as the "no-risk" nature of U.S. Treasuries, are under attack. Virtually every sovereign nation in the western world, save a handful, are either de facto bankrupt or soon will be.

Gold is an unusual asset because it has been used as money and viewed, in the hearts of men, as the ultimate store of "exchange value" for at least 7,000 years, and probably a lot longer than that. There are many complex reasons for this that we do not have the space to discuss fully; suffice to say that, in the case of instability of any type, especially economic instability, people will buy gold, driving up its price in terms of other mediums of exchange, such as the euro or the U.S. dollar.

Platinum has also been used as money, but its history is much shorter. The first evidence of human use comes from 7th century B.C. Egyptian tombs, where platinum plaques bearing inscriptions have been found. Platinum was rediscovered about 500 years ago, when the Spanish explorers found small amounts of it intermixed with gold and silver deposits. The first and so far only use of platinum as money was by the Royal Mint of Russia during the 1820s. Large deposits of platinum had been found in the Ural Mountains, and the Tsar declared platinum production to be a royal monopoly, with all metal processed by the mint.

Platinum first came into its own when much larger deposits were discovered in South Africa in the 1920s and developed in the 1930s. That is where most of the world's platinum supply comes from nowadays, with a smaller amount still coming from the Urals and an even smaller amount coming from mines scattered across Asia and the Americas. Since the 1930s, the richest platinum deposits have been exhausted, and miners have been forced to dig ever deeper and utilize ever-poorer quality deposits, resulting in steadily increasing labor, commodity and, especially, electric costs. Platinum is 15 times rarer in the earth's crust than gold, and its price will eventually recognize part of that rarity. But even though the price of platinum can and will fall below that of gold, for short periods of time as it has today, that situation is unsustainable for the following reasons.

Let us assume gold jewelry sales eventually drop by 25% because of the recession (in spite of the fact that no such dramatic drop has yet occured despite of fast-rising gold prices). Platinum is 15x rarer than gold, and total mining supply is about 188 metric tons. A shift of 7% in gold demand to platinum demand represents a shift of 116 tons, even after reduction by 25% due to the assumed drop in jewelry demand. Current world platinum jewelry demand rose from about 2.2 million to 2.4 million troy ounces in 2010, according top refiner Johnson Matthey. That is about 74.6 tons.

Assuming the shift in demand only encompasses demand for "white gold" and does not affect yellow gold jewelry at all, total platinum jewelry demand would be 190.6 tons, which alone exceeds the annual platinum mining supply. That leaves not one ounce of newly mined platinum to fulfill the existing demand for 170 tons of industrial use. Johnson Matthey reports that only about 57.5 tons of platinum are likely to be recovered this year from recycling, leaving an unfilled platinum demand gap of 112.5 tons. This is especially problematic because a growing percentage of cars are now being equipped with small diesel engines, which require eight times as much platinum for their catalytic converters as gasoline models. Where will all that platinum come from?

Platinum mining supply fell from a total of 6,830,000 ounces in 2006 to 6,060,00 ounces in 2010. This occured in spite of a substantial rise in price from about $1,200 per troy ounce back in 2006 to over $1,500 per ounce in 2010. Meanwhile, old mines are being played out and now are being dug deeper and deeper, resulting in ever-increasing energy costs. Proposed new mines are seeking to capitalize on very low grade ore deposits with the assumption that prices are headed up. Those new mines will produce product that is extremely expensive and energy-consuming to refine, like those in the eastern Bushveld of South Africa. At least one of these new projects has already been abandoned because the current price is not rising fast enough. More will follow unless there is a substantial increase in platinum prices. Moreover, even if prices were to rise into the mid-$2,000 range, it will take years to get the new mines online. In short, an increased platinum supply is going to be very difficult if not impossible to find.

Obviously, it is impossible to have a demand gap of 112.5, 100, 75, or even 50 tons of platinum. The laws of economics will force a big price rise at some point that will put platinum prices once again substantially higher than gold prices, until the price differential is high enough to dampen the gold-substitution demand. Until that happens, however, no woman in her right mind is going to choose a white gold setting for her diamond ring when she can have platinum for the same or a lower price.

Even prior to the equalization of gold and platinum prices, or the rise of gold prices above platinum prices as gold and platinum prices were starting to converge, the trends were clear. During Q1 2011, Chinese platinum jewelry demand rose by 80% over 2010 levels. North American platinum jewelry demand rose by 40% during 2010 over 2009, with jewelers reporting that the price of gold was selling platinum. Now, with platinum cheaper than gold, this phenomenon will become even stronger. It is very unlikely that platinum prices can stay substantially below gold prices for very long. They never did during the 1970s, when both metals sped upward together, and they never have in the last 250 years. That is a downside buffer.

With fiat paper money continually debased by episodes of quantitative easing by the Federal Reserve, Bank of England, Bank of Japan and the ECB, gold is certain to rise substantially over the next five to 10 years. There might be a time lag, but just as it did during the 1970s, platinum is sure to follow in gold's footsteps because the two are joined at the hip. Even if we assume that the world car industry goes into a major collapse, the shift in jewelry demand means that platinum prices must rise at at least the same pace as gold, medium to long term. This provides the prospective investor with the best of both worlds. Platinum is buffered against falling by rising gold prices while, in the longer term, it has a very high likelihood of returning to its historic 2-2.5 to 1 price ratio against gold. Platinum has more upside potential than gold at this particular time, and should now be bought by long term investors. Avid gold investors should consider an allocation to platinum.

You can invest in platinum by purchasing shares in the ETFS Platinum Trust (NYSEARCA:PPLT), purchasing physical coins or bars, buying futures contracts at Nymex and taking delivery of them, or buying stock in a platinum miner such as Anglo-American Mining (OTCPK:AAUKY), Lonmin (OTCPK:LNMIY) or Aquarius Mining (OTCPK:AQPTY). When you buy any stock, of course, you take more risk than you do when you buy the commodity itself. You will incur executive overcompensation risk, political risk (such as in Zimbabwe, where expropriation is threatened), and executive error risk (such as in building mines in countries that later nationalize them). On the other hand, generally speaking, if the risks do not materialize, a platinum stock investment will be leveraged over the commodity and you might even collect some dividends at some point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.