The Platinum/Gold Ratio is at a Critical Point

Back in January, Brian O'Flanagan wrote an interesting piece for Screwtape on the Platinum/Gold ratio. Traditionally, platinum is a more precious precious metal than gold, and its ratio has reflected that: apart from on a couple of very brief occasions, it has always been higher than 1:1.

Until the latter part of 2011 that is, when platinum plunged from its highs of $1870/oz to a heart-stopping $1360/oz (27%). Although gold suffered its own drop ($1900 to $1540/oz), it was 'just' 19% - ergo the PLAT:GOLD ratio fell to below parity for essentially the first (sustained) time in modern memory. This is visually represented in these two charts:







Thus, between August 2011 and March this year, gold was more precious than platinum. This month, however, that changed and the ratio is flirting with resistance at 1:1. At the time of writing, thanks to gold's Friday surge, platinum is again cheaper than gold, but not by much. So what does this mean for the two metals, and how can we take advantage of it?

Firstly, a couple of obvious points. The parity line (1:1) appears to be strong support/resistance. This is no coincidence: as platinum has almost always been more expensive than gold, it's a brave trader who decides to push through this barrier on the way down. Note the large black candlestick spiking up (far left, chart #1) as this line is hit: clearly there were those who thought that the heresy of second-place platinum could not be countenanced. Once it was breached, however, further falls were swift, as the heresy became adapted as the new faith with some gusto.

Similarly, once the line was breached, we can now expect it to serve as resistance, as both bulls and bears for this ratio try to work out whether we're in a new paradigm or whether the last six months were simply an aberration that can be quickly snuffed out.

Secondly, we can crudely place platinum bulls into the 'economy bulls' camp. In other words, because platinum is overwhelmingly used in industrial applications (catalysts, etc.; investment demand is only around 10% of production), one needs to be bullish about the wider economy, growth, and so on, in order to buy it. However, gold bulls can be (equally crudely) placed into the 'doom and gloom' camp, and expect the economy to stagnate, low interest rates to be maintained, and more money printed (resulting in inflation). The fact, therefore, that PLAT:GOLD is flirting with parity is perhaps symptomatic of broader market sentiment, which is divided between (a) 'hey, let's all jump on the stocks train' and (b) 'run for the hills'.

Or, to put it another way, no-one's got a bloody clue what's going on.

So, GOLD:PLAT is at a critical 'round-number' point (1:1). It's also, strangely, at a critical technical point. Let's go back to the chart:


The 50- and 200-dma are close to meeting, and so a resolution of the question of which metal is currently more 'valuable' cannot be far away. In other words, it's 'shit or get off the bog' time for the ratio: the 50-dma will cross the 200 and restore platinum to its 'traditional' pre-August 2011 status of being significantly more expensive than gold, or the two moving averages will meet, kiss, and move apart again, with the 50-dma going south. That would appear to be a confirmation that gold (thanks, presumably, to its investment status) is now genuinely more attractive to industrial platinum, a fact which in itself we might take as an indication of the health (or at least the perceived health) of any nascent economic recovery.

It's impossible to say for sure, but it looks like the latter scenario is more likely, given that the RSI, Slow Stochastic and MACD are all indicating further falls to come in the ratio. A retest of the 50-dma seems all-but-certain, and there seems to be enough firepower in the falling indicators to push it below this line. Conversely, a successful retest would be very bullish, and could allow the moving averages to cross in the near future.

That's the case, perhaps, for the ratio bears. However, the PLAT:GOLD bulls could well turn round and say, ah well, but what about the rising channel? OK, here you go:



I have to say, this isn't that convincing. It's not a very neat channel (I've kind of forced the lines to fit), and it's pretty short-term: less than three months. I'd be surprised if, from a technical view point, that this formation alone would allow platinum to push its ratio with gold through parity. Far sexier is platinum's nearly completed inverted head and shoulders, which you will recall has been appearing on all sorts of commodity charts of late, not least of which is that for gold (please see my article here):


Note that this is on the platinum daily chart, not on the PLAT:GOLD ratio chart (as that wouldn't make any sense at all...) It is broadly comparable with that seen for gold, silver and the CCI (again, see this article for the charts), and I can hardly argue that gold's IH&S will break north but make a case that platinum's will not. Either they both will (and so will silver's and the CCI's), or none of them will.

I'd say that the outlook for platinum investors is pretty bullish. But we're concerned here with the platinum:gold ratio, not platinum itself per se, and I would submit that the last chart, albeit a very bullish one for platinum, doesn't really provide any clues regarding the ratio. Both gold and platinum could rise (or fall) at the same rate (whether it be slowly or exponentially), and the ratio would thus remain static. So a bullish outlook for platinum does not necessarily mean anything in terms of the platinum-gold ratio.

I should mention a couple more things before concluding. First is that the account above is pretty much just technical analysis, which is only one-quarter of the factors that one needs to consider when trading/investing (the other three being sentiment, fundamentals and events). Platinum has not yet seen the recent speculative activity associated with gold or, in spades, silver, but this could change with Sprott's new Pt/Pd ETF. Platinum is also far more prone to events, given that 80% of production is located at just three sites in South Africa (imagine what the price of platinum would be today had the country been Mali rather than RSA?) These sorts of factors can quite simply blow TA out of the water, and must be borne in mind.

What we're really interested in is which metal will perform better, and therefore which is the better investment. And by extension - although I don't want to over-egg the pudding here - which of the two 'camps' ('doom and gloom', or 'yay, let's all buy auto-mobile shares') we're going to fall into.

All of the above is a long and convoluted way of saying that in the markets there often exist certain indicators, sometimes obscure and sometimes opaque, which can give clues about not just the future of the investment itself, but also about wider investment possibilities. They can also give hedging opportunities. I can't tell you which way this particular ratio is going to go - it'd be like flipping a coin at the moment - but I can tell you that once the situation is resolved (in the next month or so), we should have a whole host of indicators from which we can hopefully make more informed trading and investment decisions.

9 comments:

victorthecleaner said...

Jeanne d'Arc,

can you tell me a fundamental economic argument that would enforce a particular gold/platinum ratio? Say, an arbitrage, a substitution in an industrial process, or an economic argument such as "If the ratio drops too much, somebody will set up a company that does X and then the ratio will stabilize." ?

No, I suppose you cannot. The reason is that the platinum price depends on economic factors (mining costs and industrial demand), but the gold price is arbitrary, and so the ratio is arbitrary, too.

The difference between platinum and gold is that platinum is a commodity whereas gold is a currency. The above-ground stock of platinum is small (I don't know the precise figures, but probably less than one year worth of supply), and so the platinum price depends on mine supply and industrial demand, similarly to copper, zinc, yttrium, whatever. Note that no bank offers platinum accounts, i.e. bank credit denominated in ounces of platinum.

Gold, in contrast, is a currency. Mine supply and industrial demand are tiny compared to the available above-ground stock (>130000 tons). So the gold price does not depend on mine supply or production cost, but rather on the trading of the above-ground stock. In addition, there are some 1000-2000 tons of contract gold traded every day. No such thing exists in the case of platinum.

If there are enough people who (wrongly) think that gold was a commodity and who look at the platinum/gold ratio chart, the chart based ideas might work in the sort run, and you might indeed make some profit. But in the long run, the gold/platinum ratio can easily go to 30 or to 50, and there is no reason on earth why it would have to come back down again.

Regards,

Victor

Jeanne d'Arc said...

Victor,

Good points.

I wouldn't disagree that the ratio is arbitrary. The chart in Brian's original post clearly shows that: the ratio is all over the place.

However, it has been all over the place above 1:1. That's what I mean by the 'traditional' state of affairs. I therefore view it as significant that this tradition is being challenged, and I think we're on the cusp of a resolution. Whichever way it resolves, I think it will be interesting to observe. Hence this article.

I think the ratio gives clues to more general investor psychology at the moment. I think I alluded to the same point as you in this article (i.e. gold is a currency and platinum a commodity), but perhaps I should have been more explicit about it. Regardless, I think this fact only adds weight to my theory that this ratio is significant in a broader way.

A complete break down of the PLAT:GOLD ratio (to 1/30 or 1/50, as you say) implies confirmation of an important re-think of how the world views gold. A return to the status quo ante implies that the goldbugs' dreams are at the very least on hold for the time being.

JdA

Boefke said...

@ Jeanne d'Arc

Victor is right IMO here. Why compare a commodity with something that is treated as a commodity nowadays, but is clearly going to break with this perception.

It's useless in a way.

Don't know if you've ever read my post about the Gold-Silver ratio, perhaps worth reading.

http://endotworldasweknowit.blogspot.com/2012/02/gold-silver-ratio.html

Jeanne d'Arc said...

@Boefke

I have to say, I didn't expect this post to be quite so contentious! ;-)

I did read your post, at the time it was published, and thought it was great - I'd recommend it.

Look, all I can do is repeat myself, really:

All I'm trying to say is that goldbugs think that the gold bull run will continue, largely due to reasons of monetary policy. Platinum bugs (if such a term exists) could be argued to say that the world economy is about to get back on its feet, and the smart money should get into this important catalytic metal.

It's a crude generalisation (for both groups), I admit, but the premise of this article is that the PLAT:GOLD ratio gives us a tool (one tool of many, I'm sure) to assess sentiment regarding these two opposing points of view.

So I'm happy to be persuaded that this world view is too crude, too blunt, or whatever, but I don't see anything wrong with comparing a commodity with a currency in this way - especially given the fact that both are precious metals (which makes the analogy quite neat) and that there is a long established tradition for this ratio to be above 1:1, which looks like its at a decision point.

victorthecleaner said...

Jeanne,

just a couple of days ago, you refused to walk along the trail although it was pointed out to you. Alright, have a break and decide later.

Here, we are just trying to make sure you don't stray too far from that trail so you can find it again later if you decide to try.

Victor

Bron said...

"If there are enough people who (wrongly) think that gold was a commodity and who look at the platinum/gold ratio chart, the chart based ideas might work in the sort run, and you might indeed make some profit."

That's the assumption Jeanne is working from and because it is a fact (given the low numbers of holders of gold who do so because they think it will be money) I think it is reasonable to look at the ratio.

IMO the majority do get fixated on prior patterns (see popularity of technical analysis) and prior relationships (ie prices and ratios) and thus it is valid to compare them up until the point there is a "break with this perception".

Jeanne d'Arc said...

One thing I was going to say in the article, but decided against at the last minute, was that one could construct a theory that says that the gold price cannot be 'allowed' to rise until platinum resumes its 'rightful' place as the most precious precious metal.

As you know, I'm not at all a fan of such theories, but if one is given to thinking that TPTB are controlling the gold price to give the impression that the dollar is not overly devalued, then the firm establishment of gold as the most precious PM must surely also be a 'no-no' if their efforts are to be considered credible.

From this, the obvious conclusion to draw would be that gold cannot be 'permitted' to make a big move until it is overtaken once again by platinum. Perhaps that's why gold is refusing to get any upside momentum at the moment... Perhaps we just have to wait until the ratio gets back above 1:1, and then it'll be off to the races for gold ;-)

Anyway, like I say, I'm not a fan of such theories, so I didn't put it in the article. But I'll throw it out there in this comment section in case anyone has a view on it.

Warren James said...

@JdA, it's not a bad thought - after all the idea of 'platinum membership' or a 'platinum card' being of higher rank than gold is well entrenched in our western culture. By design? Probably not, but if that's the viewpoint of the market makers (right or wrong) then it makes a difference somewhere.

The classical view of Freegold (once implemented) is that the market float action will instantly show up in currency inflation. So savers who only understand nominal terms will look at gold and see that it is gaining x% per annum, versus y% in an 'interest bearing deposit'.

Here in australia, my top-level observations are that the rate of currency debasement is close to the interest rates - i.e. yes the central bank will give 'interest' on the deposit, but it's at the expense of diluting the rest of the currency. That kind of effect is just one of the mechanics I describe in my Hard Assets article from last year. Most people don't generally understand or care because the debasement doesn't occur at a level they can comprehend - they have been trained all their life to think nominally and don't understand why their productive effort seems to be being siphoned away.

P.S. the traditional view of ANOTHER is that the other metals will 'give back all their gains' as it takes center stage. But that doesn't mean that trading won't work pre-freegold.

I'm interested in all these things since for some (depending on when they buy), silver and gold have not performed even nominally as expected (or promoted) - an interesting conundrum.

Warren James said...

(enhancement) '... the other metals will 'give back all their gains' as GOLD takes center stage (as the premier wealth-preserving-asset)'.

Trying to figure out asset-percentage allocations (in metals) does my head in. Gold doesn't currently appear to behave like a wealth-preserver because of all the noise. It's a hard sell for anyone trying to figure out whether to park their stuff in gold at the minute. I guess stories of tungsten-filled bars are designed (and timed) to steer them away from real bullion and back into the gold contract game (paper). Crazy world.