Using History To Profit From The Gold Bubble: A Gold-Platinum Pair Trade

by: ChartProphet

Both a sign that gold is in a bubble and a profitable investment opportunity, platinum prices have dropped below gold prices for the first time in nearly twenty years. Platinum has consistently been worth more than gold as far back as the data goes, with gold being worth more in late 1974-July 1975, December 1980-April 1983, July 1984-October 1985, August 1991-January 1992, and October 1993-January 1994. Other than these few instances where gold was more expensive, platinum has continuously regained its title as most expensive precious metal. In fact, every time platinum prices dipped below gold prices, it turned out to be a great buying opportunity for platinum, as platinum prices recovered and even soared in relation to gold. Moreover, other than the brief 1974-1975 period during the gold bull market of the 1970s, gold prices have been higher than platinum prices only during bear markets in gold. In other words, when platinum is cheaper it is usually not a good time to buy gold. The chart below shows how platinum has been approximately equal to or more expensive than gold for most of the last 30+ years and has recently become cheaper than gold for the first time since 1994.

Source: Richard Bloch

Since platinum has historically been more expensive than gold, a great way to profit from the unsustainable gold prices is to short gold and buy platinum. Platinum will fall together with gold when the gold bubble bursts, so it is important to monitor your platinum position and make sure it isn’t falling faster than gold. Buying platinum and shorting gold allows the investor to be protected from rising gold prices while still profiting from falling gold prices. This platinum-gold “pair trade” works as follows: if gold prices continue to rise, the short positions on gold will lose value but will be offset by rising platinum prices and gains on the long-platinum positions; on the other hand, if gold prices fall, the short position on gold will gain and offset losses in the long-platinum position. Simply put, platinum should be a relative outperformer compared to gold over the next few years, since platinum has historically been more expensive. Therefore, by buying platinum and shorting gold, investors would effectively be betting that the historical relationship between gold and platinum will hold true.

A word of caution, however: platinum still has a chance of falling faster than gold even if the gold bubble collapses. If this is the case, the platinum-gold pair trade would be a loser. Moreover, a pair trade involving such highly correlated metals like platinum and gold provides very little profit potential compared to simple short bets or options strategies. To maximize profits using this pair trade, then, one should closely monitor his or her platinum position and make sure it is not falling faster than gold. Furthermore, if a gold peak is confirmed, one could remove the long-platinum position and keep the short-gold position. Other strategies could include shorting gold and buying call options on platinum, thereby limiting the risk on the long side, or limiting risk by keeping this pair trade through options only (put options on gold, call options on platinum). Regardless, this pair trade offers some insight on how to profit from the gold bubble while still protecting in case gold prices continue to rise.

Disclosure: I am short GDX. I am short GDX through put options.