Gold bubble talk, admittedly, has largely been proven silly in the short-term. Gold prices have soared 30% since April and long-term the precious metal has quadrupled in a little over six years.
But as the old saying goes, there’s no such thing as a sure thing on Wall Street. So allow me to poke one more needle at the gold bubble idea by breaking down the meteoric rise and painful crash of platinum just a few years prior. Gold investors could find the case study instructive.
For starters, let’s operate off the assumption that gold and platinum are very similar. Both are rare and pricey. Both are also used in industry – gold in electronics, for example, and platinum in catalytic converters in autos. Both are well-known hard currency investments, though gold coins and bars are obviously more common than platinum ones.
Theoretically the two metals should perform in very similar manners. Industrial demand for both metals waxes and wanes with the broader economy, and the demand from investors waxes as wanes with the broader appeal of hard assets. When gold is a good buy, platinum is a good buy. Right?
Directionally in the long-term, this is correct. But there is always one clear winner between the two.
Consider that since 2006, platinum prices have roughly doubled compared with an almost flat stock market. Gold has seen gains of nearly four-fold in the same period.
Obviously, it’s not as simple as throwing your weight behind both hard assets. They can move in much different ways and deliver much different results for your portfolio.
Platinum to Gold Ratio: A History
Finding out why one metal outperforms the other is tricky. There are many outside influences at play, but one easy way to discern which metal is overbought is by looking at the historic relationship between gold and platinum prices.
The average ratio of platinum to gold prices has been largely between 1.25 and 1.50 for the past few decades – meaning platinum typically is selling for 50% more than gold at most points in time. There are regular fluctuations, but any large deviation from this benchmark tends to result in a sharp correction back to the norm soon afterwards.
Consider the 1980 gold bubble – when platinum was on par with gold, and at times even worth less than the yellow stuff. As gold watchers should know, gold prices suffered an ugly flop of almost 50% in the early 1980s, plummeting from a peak over $710 to languish in the $375 to $475 range for the next three years.
The flip side of platinum-to-gold is also a good indicator. When platinum prices overheat and the ratio moves too far away from that 1.25 to 1.50 norm, it’s a disturbing sign that speculators are running amok. Most recently, platinum raced up from around $1,300 an ounce in 2007 to peak at almost $2,200 an ounce in May 2008 while gold hung out around $670 an ounce. At those peak valuations, the platinum-to-gold ratio was almost 3.30 – a nosebleed level that was a sign of trouble. Things quickly corrected as platinum flopped all the way down to $800 in November 2008.
What Platinum and Gold are Saying Now
In the short term, it’s worth noting that the platinum-to-gold ratio has signaled two sell signals based on the idea that anything approaching or passing 2.00 is a sign valuations are out of whack. The first was in 2006, and the second more clear warning bell came amid the commodity craze of 2008.
In 2006 platinum flopped from $1,325 in May to $1,125 in early June – a nearly 15% slide in under 30 days. In 2008 the drop was even more severe, with the aforementioned 60% slide from May to November. Gold prices were damaged similarly in the same periods. Gold went from $725 in the same 2006 window for a slightly deeper 22% decline, and fell from $928 to $713 in 2008 for a “better” but still painful 23% slide.
Now platinum-to-gold has drifted back down. In fact, it may have drifted too far as platinum prices and gold prices approach a 1-to-1 ratio.
Perhaps. One way to “correct” the ratio is for gold to plummet significantly to widen the gap.
But the other solution to this sticky ratio is for platinum to soar and outpace gold. Consider the previously discussed flop for platinum just three years ago. Platinum turned out to be oversold as it slumped all the way to $800 in November 2008 to place it neck-and-neck with gold. Investors who mined for bargain in platinum were able to profit as platinum rebounded from those lows to once again break through the $2,000 level gain just four months later.
And of course, there’s no cosmic rule that platinum-to-gold has to stay between 1.25 to 1.50 in order for the commodities to be fairly priced. Macroeconomic concerns, the accessibility of gold as a safe-haven investment due to ETFs like the SPDR Gold Trust (NYSE:GLD) and commodity hoarding by governments like China all have a lot of influence in the current marketplace.
But if you want a simple precious metals forecast, it looks like things could go one of two ways: either gold is set for a brutal fall, or platinum will go on a tear very soon.
Which side of the trade you want to be on is up to you.