Platinum Cheaper Than Gold May Signal Trouble Ahead For The Stock Market

Includes: GLD, PPLT, SPY
by: MarketGyrations

Platinum is normally worth more than gold, but economic uncertainty can reverse that.

In 2011, platinum cheaper than gold coincided with turmoil in the stock market and economy.

The current course of events resembles the one in 2011, but could turn out differently.

Both gold and platinum are precious metals, but the latter is more often than not priced higher than the former. Contrary to popular belief, platinum is actually slightly more abundant in the earth's crust than gold. However, the much smaller number of platinum mines in comparison to gold mines makes platinum a much rarer metal as gold is much more abundant above ground.

Furthermore, supply of platinum is much more concentrated than in the case of gold. Whereas gold production is spread all over the world, South Africa is responsible for supplying roughly 80 percent of all the platinum in the world. Platinum extraction is more difficult and therefore more expensive to produce than gold. All of which contributes to the higher price of platinum relative to gold under normal circumstances.

When gold is worth more than platinum

However, there are times when gold is priced higher than platinum. They don't occur all that often, but it can happen from time to time depending on the circumstances. To understand why this happens, it's important to look at the differences between how people use gold and platinum.

Platinum is a precious metal, but it's also an industrial metal if you look at how it's used. In fact, the number one application of platinum is in the automobile industry where platinum is used in a catalytic converter (autocatalyst) to help control pollution from vehicle exhaust. A weakening economy can therefore hurt platinum demand.

On the other hand, gold is treated as a safe haven with very little use in industry. When times are uncertain for whatever reason, people tend to flock towards gold. This pushes up demand for gold to the point that gold becomes more valuable than platinum. This can be expressed by the platinum-to-gold ratio.

When the price of platinum is equal to gold, the platinum-to-gold ratio is equal to one. A ratio above one means that platinum is worth more than gold. On the other hand, a ratio below one means gold is priced higher than platinum.

If the economy is relatively stable, the price of platinum tends to stay above gold. However, if economic prospects are perceived to be poor or weakening, gold will rise above platinum. Compared to gold, platinum is a much more volatile metal.

A platinum-to-gold ratio below one coincides with times of trouble

The ratio started sliding in 2011

The year 2011 offers a good example. While the first half of the year was relatively stable, the second half was completely different. As Quantitative Easing (QE) 2 came to an end in June of that year, the price ratio of platinum and gold started sliding towards one.

The market turmoil in the second half of 2011 was triggered by politics and the downgrade of the United States by Standard & Poor's in early August. This resulted in the platinum-to-gold ratio falling decisively below the magic number of one. The stock market in the form of the SPY (NYSEARCA:SPY) dropped by almost a fifth in a very short amount of time.

The SPY falls off a cliff

For those who don't remember, this period in August and September saw huge price swings in the stock market, both up and down and sometimes on consecutive days. The Federal Reserve had to respond with Operation Twist in late September to help stabilize the market somewhat.

The platinum-to-gold ratio remained below one as the market went through a series of crises in both the United States and Europe in 2012. It wasn't until early 2013 that the ratio fully recovered when stimulus from the Federal Reserve was well under way. QE3 was first announced in September 2012 starting at $40 billion a month and later expanded to $85 billion a month in December.

Platinum stays below gold

Will history repeat itself?

Fast forward to 2015 and the ratio of platinum-to-gold is again sliding towards one as QE3 has ended and the price of gold is rallying in comparison to platinum. In fact, the ratio broke below one on January 15, if only by a little bit. On this day, one troy ounce of gold went for $1,276.90 and platinum was worth $1,269.80. This turn of events is similar to what happened in the past, which is worrisome.

Whether this breakthrough is a signal that more trouble is on the way as in 2011 remains to be seen at this point. However, at the very least, the platinum-to-gold ratio of below one is an indication that there is a lot of uncertainty out there as to what the future has in store. If you haven't already done so, you may want to think about putting on some protection in the form of hedges as insurance. Time will tell whether history is about to repeat itself.

After recovering, the ratio is again dropping

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.