Bet On Gold-Platinum Parity

Summary

• Currently, gold is trading at 1.5 times the price of platinum.
• The gold/platinum ratio is likely to fall back to 1: the price parity.
• Long platinum-short gold, or long platinum outright without the short gold hedge.

Introduction

The bet on gold-platinum parity might be one of the top trades now, based on risk-return profile. Historically, the price of platinum (PPLT) has been higher than price of gold (GLD). However, recently gold has been trading at a very high premium to platinum. This is a temporary disequilibrium and the price of gold and platinum will likely reach parity.

Here is a long-term chart of gold (in blue) and platinum (in black):

Currently, gold is trading at $1700/ounce while platinum is trading at $1130/ounce - which is highly unusually based on historical data. The next chart shows the gold/platinum ratio since 1960s.

Based on the chart above, gold has been trading at discount to platinum most of the time, and the parity line of 1 served as a major resistance from early 1970s until 2014. The trend of rising gold/platinum ratio broke the parity line and accelerated in 2015, and reached the peak in March of 2020 during the Covid19-related lockdown, when the price of gold was 2.2 times higher than price of platinum. Since the announcement of an effective Covid19 vaccine in November of 2020, the gold/platinum ratio plummeted - and yet the price of gold is still 1.5 times the price of platinum. It is likely that the trend of falling gold/platinum ratio will continue until it reaches the parity line.

Why is the gold-platinum ratio in disequilibrium?

All commodities are affected by 1) common macro factors and 2) commodity-specific supply/demand dynamics.

Common factors that affect commodities as an asset class include the US Dollar cycle and inflation expectations. For example, commodities tend to appreciate as the US Dollar weakens and inflation expectations increase. However, the inter-commodity spreads should remain relatively stable when commodities respond specifically to common macro factors.

On the other hand, each commodity also responds to its' own supply/demand dynamics. Thus, there is always some lead-lag in movement of different commodity prices based on short-term supply/demand dynamics, which should be reflected in temporary deviations in inter-commodity ratios. For example, a temporary supply shortage in one commodity can affect the price of that commodity only.

Gold is primarily a precious metal, and a safe-haven asset. Platinum is also a precious metal, but also an industrial metal with 30-40% of demand from an automotive industry. Thus, both gold and platinum should be equally affected by weakening US Dollar and inflation expectations. However, platinum will be much more affected by economic growth expectations due to its industrial use.

Thus, the disequilibrium in the gold/platinum ratio is based on either a macro inefficiency where gold is overvalued or platinum undervalued, or a platinum-related supply/demand dynamics.

Some statistical evidence

I examined the recent data from 2000 to 2021 and computed some statistical calculations.

• First, gold and platinum have only a modest correlation of 0.57.
• Platinum has the highest correlation with crude oil at almost 0.90, while gold has the highest correlation with 10-Year Treasury Note futures at 0.90.
• Platinum has only 0.30 correlation with TNote futures.
• I also examined some causality tests and find that TNote futures actually Granger cause gold prices - meaning rise in Bond prices actually causes higher gold prices (in vice versa).
• In addition, copper and oil both statistically cause platinum prices - meaning higher copper and oil prices cause higher platinum prices. Thus, platinum is more sensitive to a cyclical economic growth.

The statistical evidence provides the fundamental thesis in support of the bet on gold/platinum parity. Gold has primarily responded to lower interest rates (higher bond prices) and rose strongly since 2018. On the other hand, a sluggish global economic growth in recent decade held down the price of platinum. In addition, the dieselgate scandal negatively affected the platinum demand since 2015. The post-pandemic opening reverses these trends, as higher global economic growth is expected, which should positively affect the price of platinum, while falling bond prices should put some restrain on price of gold.

Thus, the gold/platinum ratio disequilibrium reflects both cases: 1) platinum failed to efficiently respond to the common factors affecting precious metals, and 2) platinum responded primary to its' own bearish supply/demand dynamics.

Implications and Strategy

I have recently noted that macro economic fundamentals are bullish for gold, as real interest rates are expected to remain negative - inflation expectations will rise faster than long term interest rates, which will be likely managed by the Fed.

However, the macro economic fundamentals for platinum are even more bullish for platinum, mainly due to the use on platinum in a green hydrogen economy. In fact, the demand for platinum due to green hydrogen provides a long-term bullish supply/demand dynamic, and essentially reverses the recent bearish dynamics.

In addition, all common macro drivers positive for gold (negative real interest rates) are also positive for platinum, while the negative driver for gold (higher interest rates) is not necessarily negative for platinum. Thus, the fundamental case for the gold/platinum parity trade is strong. The trade can be executed in two ways:

• Long platinum and Short gold. The gold/platinum parity can be reached by either platinum catching up with gold or gold catching down with platinum. In this case, the long platinum-short gold trade would be an appropriate strategy. The scenario of gold catching down to platinum would involve a sharp rise in interest rates, crushing the gold prices, while strong demand for physical platinum keep the price of platinum stable. The scenario of platinum catching up to gold would involve a modest rise in interest rates which would keep gold relatively stable, and a very strong post-pandemic economic growth positively affecting price of platinum.
• Long platinum only. Given the macro environment, it is likely that both, gold and platinum will likely continue to rise, but platinum will rise much faster to catch up with gold. Thus, the long platinum trade without the short gold hedge might be the most aggressive strategy - implying a much higher return, but with higher risk.

The Risk

What is the chance that 1) gold continues going higher while platinum remains steady or reverses lower - the increase in gold/platinum ration, or 2) the price of platinum collapses relative to gold?

A global economic recession would cause a lower platinum price, along with lower copper and oil prices due to lower demand for industrial commodities. Further, a global recession would cause lower interest rates, which would likely boost gold prices. In such an environment the gold/platinum ratio could continue to increase. However, due to the expected economic recovery in a post-pandemic world awash with fiscal and monetary stimulus, the chance of a global recession over the next 12 months is probably close to zero.

There are also specific risks to the platinum supply/demand dynamics that need to be considered. For example, there could be synthetic platinum substitutes in a green hydrogen economy, which could affect the platinum demand. Further, platinum can be very volatile due to the low liquidity and the price could crash in an liquidity-driven sell-all moment.

Analyst’s Disclosure: I am/we are long XPTUSD:CUR. 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.