Platinum will reach a historical high of $2,700.00 per ounce by year end 2011. My yearend target for 2010 is approx $1,980.00 per ounce. The primary dynamic over the long term in deriving these price targets comes from looking at the relationships between the historical spread of platinum over gold and in context of power restrictions from South African state run utility ESKOM. In the short term, platinum prices will be determined by the strength of the industrial economy. Industrial strength will be measured by proxy using the following; North American Rail Traffic, both Domestic & World auto sales, distillate fuels used in utility & transportation, and a look into the scrap steel market.
The WSJ reported a 4.6% increase in North America Rail Traffic during the month of December; this represented the first yr-on-yr increase in over a year. Among top rail users are the coal industry, car dealers, and construction & manufacturing firms. Increased coal serves utilities which are seeing increased demand for electricity used in manufacturing.
“Bunker fuel” which is not traded as a financial asset such as crude oil or Nat. Gas, therefore isn’t exposed to wide speculation has made fresh highs recently. Due to its high sulfur content bunker fuel is used by power plants and maritime fleets. Therefore we will use the rising price of bunker fuel to serve as a proxy for increased demand in transportation using ships (dry bulk, container, etc.) and ultimately increased demand for world trade. The spread of bunker fuel to crude oil has narrowed to $3.5/bbl, the lowest in 3 years.
China, India, & Japan saw an increase in diesel demand during the fourth quarter, while U.S. inventories experienced a decline. Anecdotally the price of diesel at the pump is now again higher than the price of premium signifying a pickup in Semi-truck traffic. Diesel is also used in Rails and Farm machinery.
Auto sales have stabilized at approx 10.4 M SAAR units during 2009 in the U.S. and are forecast to increase to 11.5-12M for 2010. The cash for clunkers program increased demand, gave an adrenalin shot in the arm to the industry, and spurred growth in GDP. Wilbur Ross has recently announced that the U.S. should implement a longer lasting cash for clunkers program which would be simpler in its structure. In China, during 2009 auto sales eclipsed the U.S. for the first time in history and rose to approx 13.6M SAAR, and are forecast to top 15M this year. Net personal income for China’s 1.3 Billion people is on the rise, this will undoubtly translate into increased demand for cars.
The Scrap Steel market was former Fed Chairman Alan Greenspan’s favorite single economic indicator during his tenure. He would look to the pricing of scrap steel to determine when industrial demand growth was taking hold. To the left is a chart from the LME for scrap steel prices during 2009.
Although steel prices have undergone a major shift from being diversified across the world, to now where production has been more concentrated in Asia, industrial manufacturing is shown to be on the mend as prices in the U.S. have been picking up. Note: It appears the flood of scrap steel from Cash for Clunkers shows up in the dip in scrap steel price from Q3-Q4.
Historical Spreads –
Below is a chart of Gold to Platinum ratio from Bespoke Investment Group. You will notice that platinum has been outperforming gold since platinum bottomed out around 750 last year when the relationship was 1 to 1. I believe this trend can continue until around 0.55 – 0.53, which translates into platinum trading at a 1.8 – 1.88 premium to gold. The minimum of 0.4 on the chart translates to a premium of 2.5, this is simply just the inverse so I may express in terms of platinum/OZ.
As you can see from the chart below Platinum topped out at approx 2290 during the first half of 2008 during serve power restrictions in South Africa disrupting supply of the precious metal. Since then platinum has rallied and more recently has broken past the 1520 level which was a 50% retracement from the low of 750. The next level of resistance would be at around 1700 which represents a 61.8% retracement from the lows.
Price Target –
Looking at the above economic indicators it appears that industrial demand is taking hold while inflation is moderate and fear gauges (NASDAQ:GOLD) is slowly starting to dissipate. This was my thesis for the long platinum/short gold trade. With demand picking up for Platinum Group Metals (PGM’s) any disruption in supply could cause the price to skyrocket. That is concerning considering that South Africa still has limited power supply from its state run electricity company ESKOM. In 2008 during the last power restrictions ESKOM announced plans to build additional capacity for its mining interests, this was projected to take at least 4 years (very capital intensive, I work for a utility). The market has put this on the back burner as demand dropped, however with the World’s platinum mines being concentrated in South Africa, this is still a big problem when demand comes back.
So let’s look at some potential price targets:
Using the historical spread from Bespoke’s chart we can say that Platinum under stress should trade at 1.8-2.5x the price of Gold. Using various scenarios for gold @1100, @1200, and @1500 we can infer the following;
@1100 @1200 @1500
1.80x 1980 2160 2700
1.88x 2070 2255 2820
2.50x 2750 3000 3750
To put the above in context Platinum hit an inflation adjusted high of $2322 in 1980. Recently a slew of analysts have come out with Gold targets for $1500, assuming we get there a 1.8x premium for 1500 gold is 2700 an OZ for Platinum. As you can see from the chart, there are a couple scenarios that will yield 2700/OZ Platinum. Also, just a side note, the new PGM’s ETF’s should cause prices to elevate higher due to asset allocation by institutional investors and speculators, however none of these measures are included in the analysis, as they say it’s just icing on the cake!
Thus my YE2010 target is $1980 and YE2011 target is $2700, as always I recommend you hedge any long position you have, and in this case I have used Gold.
I have no long or short positions in Gold, Platinum or PGM’s or equities whose price is derived from the underlying metal.
Bespoke Investment Group
Disclosure: I have no long or short positions in Gold, Platinum or PGM’s or equities whose price is derived from the underlying metal.