Our Scarcity Driven Metals Pair Trade

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Includes: DGL, DGZ, GLD, IAU, OUNZ, PGM, PPLT, PTM, SGOL, SPPP, WITE
by: FX Metrix, LLC

Summary

We have been watching the precious metals lately, and we see opportunity for a pairs trade: short gold, long platinum.

We compare scarcity and utility for the two metals to clarify our underlying economic assumptions. .

Since this trade can either be done using futures contracts or ETF's, we recommend various gold and platinum ETF's that can be used for this or the opposing pairs trades.

Background
Precious metals have been on the rise recently, yet there is one pair in particular that we are focused on. These two extremely rare metals are platinum and gold. In the last three months, gold is up just shy of 10%. Over the same period however, platinum is down roughly 1.75%. In terms of spot price for the two metals, below is a table comparing platinum with gold in terms of U.S. Dollars per troy ounce.

Metal Platinum Gold
USD/oz. (2/8/2016) $924.00 $1195.00
Click to enlarge

PPLT Chart

Historically Odd
As seen in the spot price table above, platinum is >$270 cheaper than gold on a per troy ounce basis. Historically this is odd, as platinum has not always been cheaper than gold... it used to be the reverse.

We decided to detail the logic and considerations behind our proposed metals pair trade based on aspects such as scarcity and overall utility. Below is a chart comparing historical platinum prices with historical gold prices for reference sake (platinum in candlesticks, gold in the vermilion line)

Click to enlarge

Scarcity and Rarity
First and foremost, platinum is a rarer than gold and therefore it is a more finite resource. Platinum has a 'crustal abundance' (abundance in the earth's crust) of only 0.000037 parts per million. Gold on the other hand has a crustal abundance of 0.0013 parts per million. That is a gold to platinum abundance ratio of roughly 35:1. Another major differences between gold and platinum are their uses.

Utility
Gold has one main purpose: a store of value in bullion form. Gold has been used in this regard for years, and is the go-to investment when there is a rise in doubt regarding fiat currency. Platinum however is not nearly as popular for storing value, however its numerous other uses make it a vital resource for various applications. Listed below are lists of select uses for the various metals.

  • Platinum Uses: Catalytic converters, jewelry, chemical catalysts, computer hard disks, chemotherapy agents, pacemakers, infrared devices, and more
  • Gold Uses: Store of value/coinage, jewelry, dental crowns, audio electronics, and more

Platinum Demand Growth Beyond Jewelry
Based on platinum's many uses, we believe there could be foreseeable growth in platinum demand. In determining an outlook, more significant than just different applications that the metals are used for is the percentage of consumption attributable to each use. As for gold, the majority is used in bullion, jewelry, and decorative applications. While approximately one third of platinum consumption is attributable to jewelry, there is one industry that uses far more platinum than them all: autos and trucks.

Automotive Industry Drives Platinum Consumption
The largest usage with regards to platinum consumption is automotive catalytic converters and the like. Whether for trucks, buses, or automobiles, platinum is a highly sought after catalyst for use in emissions related parts such as catalytic converters. Additionally, there is a small amount of platinum or similar metal such as palladium used in most spark plugs for a long lasting and dependable electrode contacts.

On a side note related to platinum demand for diesel vehicles: many are saying that the VW (OTCPK:VLKAF) emissions scandal is bad for the diesel car industry. The outcome will likely lead to higher scrutiny regarding diesel emissions. This means that auto makers will need to require more from their catalytic converters and emission prevention devices. While this may cause a rise in diesel vehicle costs, this rise in catalyst demand will actually be a good thing for platinum demand.

Platinum and the Medical World
While only approximately 2% of platinum is used in the medical industry, we believe that as more research goes on, that this has the capability to grow tremendously. Not only is platinum used in the dependable electrodes of pacemaker devices for heart troubles, but it is also being used to fight cancer in cutting edge chemotherapy agents.

Because of platinum's usage in chemotherapy agents called platinum-based antineoplastic drugs, medical platinum consumption has the potential to go way higher. While there are numerous different types of these drugs out there for various cases, they are highly useful in stopping cancer cells from interacting with DNA. Additionally, there are new platinum-based antineoplastic drugs for different cancer applications still being developed. These drugs have been game changing in relation to testicular cancer treatment among many other types and treatments. Cancer is a big ticket item, and until cures emerge, these highly effective drugs may be necessary for treatment.

Platinum as an Investment?
As more become privy to the tremendously useful as well as scarce metal, platinum may even gain investors acceptance as a storage of value similar to that of gold. This would cause a significant increase in platinum consumption, as currently it is not widely held in the investment community. The creation of ETFs which hold platinum create a far easier means of platinum investment for the average person that beats purchasing and storing bullion. In addition, they bring the idea of investing in platinum into to real of possibilities for those with IRAs not suited to hold bullion.

Gold investment through ETFs skyrocketted in popularity since their invention, and if a similar thing were to occur with platinum, it would drive up platinum demand and prices significantly. For comparison sake: ETFS Physical Platinum Shares (NYSEARCA:PPLT) currently has 453,131 troy oz. of platinum. Compare this to ETFS Physical Swiss Gold Shares (NYSEARCA:SGOL), which is not even the largest physical gold trust, holding 726,585 troy oz. of gold. SPDR Gold Trust (NYSEARCA:GLD) has 22,300,607.29 troy oz. of gold. A complete list of ETFs applicable to this pairs trade is included at the end.

Longer Term Risks to Platinum Prices
First and foremost, one risk in the short term is mining supply. As most platinum is mined in South Africa, miners have been overproducing to some degree in order to combat a weak South African Rand. Higher output volume allows the mining companies to combat falling revenues from lower prices.

It should also be noted that one risk to our long platinum thesis is that certain highly recyclable applications of platinum such as catalytic converters make it so that approximately 25% of platinum's supply is from recycling and rising. Platinum recycling efforts can keep a slight pressure on prices. This makes it so there is less demand for newly mined platinum.

Additionally (this is highly futuristic, yet worth mentioning), there is rising investment into research and development regarding asteroid mining. While this will take tremendous time to get running if at all possible, it would cause a significant increase in supply of platinum as well as other minerals.

ETFs
As mentioned above, while one could certainly use futures as a means of getting exposure to this pairs trade, getting exposure to this pairs trade does not have to be that difficult. Below are a handful of selected ETFs that one could use to gain exposure to each side this pairs trade.

  • Platinum: ETFS Physical Platinum Shares , E-TRACS UBS Long Platinum ETN (NYSEARCA:PTM), iPath Bloomberg Platinum Sub-Index Total Return (NYSEARCA:PGM), Sprott Physical Platinum & Palladium (NYSEARCA:SPPP), ETFS White Metal Basket (NYSEARCA:WITE)
  • Gold: SPDR Gold Trust , COMEX Gold Trust (NYSEARCA:IAU), Physical Swiss Gold Shares , DB Gold Fund (NYSEARCA:DGL), Van Eck GoldTrust (NYSEARCA:OUNZ), or even use the DB Gold Short ETN (NYSEARCA:DGZ)

Since this is a longer time horizon trade, ETF expenses should be a consideration, so be sure to consider our article comparing the gold ETFs here. Also be sure to consider our article comparing the platinum ETFs here.

Conclusion
We hope that people find this longer term pairs trade interesting and useful. We will be sure to keep people informed on any new developments in this pairs trade. As mentioned previously, we have a long term horizon on this one, and plan to ride it until this metals pricing phenomenon corrects itself.

References

Platinum Rarer Than Gold

Platinum Periodic Table Info

Gold Periodic Table Info

Anti-Cancer Platinum Drugs - Further Reading

Spot Metals Prices

World Platinum Investment Council

WPIC Platinum Demand Outlook

Asteroid Mining Article

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Consult you investment adviser.