Platinum and Silver Lag Gold

Commodity Exchange report
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Volatile market conditions reflecting the global political and economic landscape caused the price of gold to rally in early 2016. Gold closed 2015 at around $1060 per ounce; by early March 2016 the yellow metal was trading at around $1255 – an increase of $195 or 18.4% over the first ten weeks of the year. The move was particularly strong given that gold had declined by 10.46% in 2015. Gold made up all of those losses and more over the first seventy days of 2016.

Gold outperformed virtually all other assets during the period. Flight to quality buying lifted the price of the traditional safe haven metal. Gold’s resurgence in early 2016 has been dramatic.

Many times when a commodity in a particular sector moves in a big way, it takes other raw materials with similar characteristics along for the ride. For example, a strength or weakness in copper historically translates to similar price pressures on other non-ferrous metals. In the world of precious metals, the historical price relationship between these rare assets generally results in strong correlations. Gold, silver, and platinum all have industrial applications. However, investment demand generally determines the price path of each of these rare metals. When investment demand for precious metals increases, this tends to touch each of the metals. While gold has always been the main event in the world of precious metals, silver has been “poor man’s gold” and platinum “rich man’s gold”.

These nicknames are testament to the historical price relationships and correlations between the metals. The bottom line, they tend to move higher or lower together.

I have written pieces on the silver-gold ratio and the platinum-gold spread in the past. Over the past forty plus years, the average level of these inter-commodity spreads have served as a guide of value for many who trade and invest in these assets.

The four-decade swing point for the silver-gold ratio has been around 55:1, or 55 ounces of silver value in each ounce of gold value. Historically, when it trades below this level silver is expensive on a value basis relative to gold. When the ratio trades above 55:1, silver is cheap on a value basis relative to the price of gold. Value is different than nominal price. When the ratio is low and silver is ‘cheap’ it could also mean that gold is expensive at that level or vice versa. The reason that the 55:1 level is so important is because when extensions above or below have occurred over the forty year period, this relationship tends to revert back to that mean level.

When it comes to the value relationship between platinum and gold, the median over the past four decades has been around a $200 premium for the price of platinum over the price of gold. With a nickname like “rich man’s gold” it makes sense that the long-term value proposition for platinum is a premium to gold. The rarity of platinum and its higher production cost relative to gold accounts for the historically higher price.

The 55:1 level against silver and $200 premium for platinum over gold are midpoints, nothing more.

Both of these relationships have seen huge extensions or deviations from the averages over the years. In 1980, the silver-gold ratio moved to 16:1, gold was $800 and silver traded at $50 per ounce before the price relationship reverted to the mean. In 2008, the price of platinum exploded to a $1200 premium to the price of gold before falling back to the mean. In these cases, both silver and platinum were expensive relative to gold on a historical value basis. Both relationships eventually returned to historical norms.

In 2015 and 2016, these price relationships have gone the other way. Gold has outperformed both silver and platinum and in the case of the “rich man’s gold” that outperformance has resulted in a new historical extension or divergence that has been unprecedented.

Prior to 2015, any divergence in terms of weakness in the platinum price versus the gold price only resulted in a discount for platinum under gold of $175 per ounce.

In 2015, the divergence briefly reached a $200 discount. Recently, in late February and early March of 2016, platinum traded at all-time lows of a $320 discount to the price of gold. On a historical basis, platinum had never been so cheap relative to gold, or gold had never been so expensive relative to the price of platinum. At the same time, the silver-gold ratio moved to over 83 ounces of silver value in each ounce of gold value. The extension in gold’s value proposition against silver reached the widest divergence since 1995.

Gold has been historically strong against its precious cousins, silver, and platinum, in 2016. This tells us that on a historical basis, either gold is too expensive, silver and platinum are too cheap or a bit of both. These price relationships tell us a lot about value within the precious metals sector. The deviation from historical swing points is a sign that there has not been a validation of gold’s strength from other precious metals. Alternatively, the deviation could be a harbinger of higher silver and platinum prices in the future as they may catch up with their yellow cousin.

Over four decades, these price relationships have tended to revert to long-term swing points. However, when extensions occur they can last for a very long time. In the case of platinum versus gold, the spread has traded below the long-term norm since 2011. The silver-gold ratio has traded above the 55:1 level since 2012. In early 2016, both of these price relationships are telling us two things. Gold is expensive on a value basis against other precious metals or the silver and platinum prices lag the yellow metal. Time will likely correct those divergences.

Many professional traders look for opportunities when markets extend from historical norms. The market participants use this type of divergence to construct mean reversion trades.  These are risk positions that make money when historical relationships revert towards mean levels. The current divergence in precious metals would lead these risk takers to go long silver and platinum and short gold simultaneously in order to profit from mean reversion. When that happens those trades result in profits, however, in markets there are no guarantees. Market extensions can always take deviation to new highs or lows and, in that case. those with mean reversion risk positions will lose money.  

The bottom line in early 2016 was that on a value basis gold was more golden that it had been in a very long time and silver and platinum were not quite so precious.