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Gold is overvalued relative to platinum group metals (e.g., rhodium, platinum). Investors should consider buying out-of-the-money puts on gold-related securities and going long platinum group-related securities.

Arguments for Gold

Many investors have flocked to gold, causing the price to skyrocket. Unfortunately, these prices cannot be justified because gold is a mostly useless precious metal whose lack of income defies valuation. Arguments supporting the value of gold easily tarnish:

Gold is a great investment because it always goes up in value. No, it doesn't. This is a terrible mantra that did not hold true for Beanie Babies or for residential real estate. It also hasn't held true for gold: it spikes and drops.

Gold is a great investment because it is an inflation hedge. There is no mechanism that forces this relationship. Investors seeking inflation hedges ought to consider inflation-linked bonds, adjustable rate bonds, or taking a short or put position in bonds with high durations.

There is increasing demand for gold in the real economy. Most gold jewelry is not pure gold but an alloy of gold and other metals. For example, 14 karat gold is 14 parts gold and 10 parts another metal. Moreover, there are convincing jewelry pieces which use gold plating or another metal altogether.

Gold is valuable as a collectible. This is almost never discussed because it seems less "economic" than the other arguments. On the contrary, it is the best argument for gold as an investment. There is considerable history surrounding gold, which helps establish its psychological value. Gold bugs do not like thinking of precious metals as collectibles like works of art or sports memorabilia. Regardless of their sentiments, gold is similar to fine art in that it has been a part of history. However, recently minted coins or bars are fungible and the fact that they are interchangeable undermines their value. Many other collectibles are unique.

Problems with Current Gold Prices

There are many indicators which make reveal how gold is overvalued at today's prices. Consider the following precious metals data from the January 26th, 2012:

Precious Metal

g/mole

$/Troy Oz

$/ gram

$/mole

Gold

107.87

1,737.60

55.87

6,026.17

Platinum

195.08

1,619.00

52.05

10,154.32

Rhodium

102.91

1,425.00

45.81

4,714.80

Precious Metal

$/Troy Oz *

Crustal Abundance** (ppm)

Reserves***

(Metric Tons)

Gold

1,737.60

0.004

51,000

Platinum

1,619.00

0.005

14,500

Rhodium

1,425.00

0.001

3,000

Palladium

691.00

0.015

43,500

Ruthenium

~ 95

0.001

3,000

Iridium

~ 1,050

0.001

3,000

Osmium

~ 380

0.0015

4,000

Gold is currently priced higher than platinum. Gold should trade at a lower price than platinum primarily it is largely inert while platinum's reactivity makes it a valuable ingredient in chemical processes. Moreover, gold is mined more extensively than platinum, which means there is more supply. For example, there are 2,700 metric tons of gold produced annually while there are roughly 178 metric tons of platinum produced annually.

Gold is currently priced higher than rhodium. This should scare gold bugs. The crustal abundance of rhodium is much lower than that of gold. Rhodium is also more precious than gold because it has amazing chemistry. Rhodium is highly coveted by chemists and chemical engineers in need of catalysts to facilitate chemical reactions. By comparison, gold is a paperweight.

Gold is currently priced higher than its production cost. For most gold miners the cash costs of producing one troy ounce of gold is roughly $600. Yet demand for gold has increased its price to almost three times this price. Investors seeking commodities at low prices should wait for their prices to drop below the cost of production, a condition which will cull high-cost producers and reduce supply. Waiting takes nerve, especially as new highs are achieved.

Playing Precious Metals Markets in January 2012

A long position in platinum group metal securities hedged by out-of-the-money puts on gold securities would exploit a cross-over in rhodium and platinum with gold. Investors should consider buying puts on a gold-linked security like SPDR Gold Trust (GLD) or a high-cost gold producer like Harmony Gold Mining (HMY). Investors should then construct a long position by buying ETFS Physical Platinum Shares (PPLT).

Platinum Fund

Ticker

Premium

Expenses

ETFS Physical Platinum Shares

PPLT

0.07%

0.60%

Path DJ-UBS Platinum TR Sub-Idx ETN

PGM

0.25%

0.75%

UBS E-TRACS Long Platinum TR ETN

PTM

24.43%

0.65%

First Trust ISE Global Platinum

PLTM

0.97%

0.70%

PPLT appears preferable to the other funds on this list because of its lower expense, lower premium to net asset value, and its direct investment in physical platinum. In contrast, PGM and PTM are exchange-traded-notes backed only by the credit of a counter-party. PLTM is different in that it invests in shares of mining companies, which will be somewhat disconnected from price movements in platinum metals.

Please read the article disclaimer.

*Prices for low-volume metals are less mid-points between bid and ask prices marked by a ~.

**Values were taken from the CRC Handbook of Chemistry and Physics

***World reserves for the gold were taken from the United States Geological Survey 2012 Gold publication. Platinum group metal reserves were estimated by multiplying relative crustal abundance by USGS 71,000 metric ton estimate for all platinum group metal reserves.

Source: Gold Is Overvalued Relative To Platinum Group Metals