ETFs: How About The Other Precious Metals Duo (PALL, PPLT, GLD, SLV)

Sumit Roy:  There’s been much discussion about the recent rally in silver. Prices for the white metal have gone absolutely parabolic recently, rising over 42 percent since the start of the year. Will the $50 record set back in 1980 when the Hunt brothers tried (and failed) to corner the market be surpassed? Who knows; when you’ve got momentum like this, anything can happen.

But it isn’t just silver’s absolute price performance that’s been so astonishing. Consider silver’s appreciation relative to gold prices. The yellow metal is only up a fairly modest 5 percent this year—a bit underwhelming considering prices seem to hit a new record every time we take a look at the headlines.

This divergence in the performance between the two metals has made silver the most expensive it has been relative to gold in 28 years. Precious metals watchers often use the gold/silver ratio to illustrate the value of gold relative to silver. In this case, a picture says a thousand words:

Gold/Silver Ratio
Source: Bloomberg

Bulls will argue that as long as the rally in precious metals continues, the ratio has nowhere to go but down, as silver acts as the higher beta play in the space. But I’ll say it again—who really knows if prices will continue to spiral higher or whether the ratio will continue lower, or what have you? All we know for sure is that silver is pretty darn expensive vs. gold relative to recent history, not to mention that gold itself is pretty lofty at $1,500.

Lost in all this conversation has been the other precious metals duo—platinum and palladium. After the Japanese earthquake, these two metals got hammered amid all the auto industry shutdowns and haven’t recovered since. Meanwhile, gold and silver continued to surge.

That means that the relative value of platinum and palladium versus their precious metal cousins, gold and silver, has dropped significantly. Here again, a ratio is illustrative.

The platinum/gold ratio is around 1.18, or near the lowest levels in two years. For much of the last decade, the ratio had been above 1.5, even 2. Platinum’s role as an autocatalyst accounts for 40 percent of total demand for the metal, thus Japan’s woes have had a significant impact. At the same time, investment demand represents only about 6 percent of total demand; small potatoes relative to gold’s 38 percent and silver’s 26 percent.

Platinum/Gold Ratio
Source: Bloomberg

Perhaps this means that platinum is the metal that investors should be looking at right now to get their precious metals exposure. If the platinum/gold ratio reverts back to 1.5, prices for platinum could rise by 26 percent, assuming flat gold prices. On the other hand, the platinum/gold ratio was consistently much lower during the ’90s; are we reverting back to that old paradigm?

What about palladium? Here too, we’ve seen a drop in the metal’s relative valuation (a rise in the gold/palladium ratio). But the move looks much less dramatic, because up until recently, palladium had been leading the precious metals charge. In fact, in 2010, it was the best performer in the sector.

Gold/Palladium Ratio
Source: Bloomberg

Autocatalyst demand accounts for a whopping 58 percent of total palladium demand, as new technologies have allowed manufacturers to increasingly substitute the cheaper metal for platinum. Meanwhile, investment demand represents 8 percent of total palladium demand.

Platinum/Palladium Ratio
Source: Bloomberg

The best course of action may then be to buy both platinum and palladium. They’ve each suffered relative to gold and silver; thus, they may both rebound when the outlook for the auto industry improves.

The ETFS Physical Platinum Shares (NYSE:PPLT) and ETFS Physical Palladium Shares (NYSE:PALL) are the biggest exchange-traded funds for platinum and palladium, respectively. While going long these funds in lieu of something like a SPDR Gold Trust (NYSE:GLD) or an iShares Silver Trust (NYSE:SLV) is one way to take advantage of platinum and palladium’s relative value, some bold traders could even consider putting on pair trades by going long one fund and shorting another. Of course, if gold and silver continue to outperform platinum and palladium, that’s going to backfire.

Written by Sumit Roy From Hard Assets Investor (HAI) is a research-oriented Web site devoted to sharing ideas about hard assets investing. The site has been developed as an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures and gold (the three major components of the hard assets marketplace). The site will focus on hard assets investing without endorsing or recommending any particular investment product.

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