Precious Metals Pair Trade
Research for Online Investors

by John Dalt

10/18/11

Precious metals have been beaten like the neighbor’s dog, and given us an opportunity. Silver is down almost 40% from its high in the spring. Gold is 13% off its high at the beginning of September. The kicker is, platinum is off 20%. Why is that important to know? Because platinum is 30 times scarcer than gold, plus we need it. Platinum is used in catalytic converters. About half of the world’s production goes into exhaust systems for new cars, and developing countries are buying cars.

Platinum has fallen so much, it is actually cheaper than gold.  It happened once before, in March 2009 during the market crash.  Here is a chart of spot platinum divided by spot gold.

I have drawn a line at the 1.2 line.  This is where platinum is priced 20% higher than gold.  We can say with certainty the present situation will not last.  Gold either needs to fall in price while platinum maintains its price, or platinum will increase in price faster than gold.

While a 20% premium for platinum over gold looks good historically, even the market returning to a 10% premium will net us a nice 18% profit.

You can buy platinum with the PPLT etf.  Like SLV for silver and GLD for gold, each share represents approximately one ounce of platinum.  One way to play this opportunity may be as a pair trade.  Buy PPLT and short GLD.  You will make money however the market corrects this mismatched price.

If both rise and I am right, platinum will increase in price faster than gold giving you a profit on platinum larger than your loss on the short gold position.  If they both fall, and I am right, gold will fall more than platinum.  This will result in a larger profit on the short gold position than the loss on the long platinum position.  If PPLT moves higher while GLD holds steady or falls you win big.  The same with PPLT holding steady and GLD falling.

The important point is the market will correct this imbalance, and you can win with a pair trade in platinum and gold.  If you are unfamiliar with pair trades, you may want to review our article “Introduction to Pair Trades” under Investor Resources at www.galtstock.com

China reported third quarter GDP grew at a 9.1% rate this morning.  This was down from second quarter growth of 9.5% and 9.7% in the first quarter.  China has raised interest rates five times in the last year and increased reserve capital requirements on banks to slow inflation in the economy.  Consumer prices increased 6.1% in September.

The U.S. economy grew at a 1.3% rate in the second quarter and the eurozone’s GDP increased 0.2%.  China is concerned with lower exports to these slower growing export markets.  They want to increase domestic consumption.  Retail sales were up 17.7% in September after a 17.0% growth rate in August.  HSBC’s economics department wrote in a research note, “While external slackness will likely bite China’s exports growth in the coming months, the strength of domestic demand should keep the economy growing at around 8.5% to 9.0% in the coming quarter.”

Angela Merkel, Chancellor of Germany, addressed her Christian Democrat caucus this morning.  She told them that bank recapitalization will be discussed this weekend when leaders meet.  She also raised the possibility of a permanent surveillance by the “troika” of countries that receive help from the European Financial Stability Facility, and taking them to the European court if they do not follow.  The “troika” consists of representatives from the IMF, the European Commission and the European Central Bank.

This is an escalation of the oversight that may be required of debtor countries and solidify control over sovereign nation’s budgets by the eurozone.  Moody’s said France’s Aaa credit rating might be reviewed because of the region’s debt crisis.  This is the danger for France, and for that matter Germany.

The two leading economies could see their credit ratings damaged because of the additional debt they incur or guarantee as a third party to rescue Greece and other troubled members of the eurozone.

The market reversed losses this morning and turned higher on the news out of Germany that progress seemed on track to address the eurozone credit crisis.  The market has a bullish feel to it.  Investors and traders seem to want to ignore bad news.  We think the next assault on 1220 will be successful and the S&P could push up to 1240 or 1260.  Institutional buyers showing up every day in the last hour is becoming a crutch for the market.  Watch out for bad news or when the “big money” stays home.

Quote:
The current crisis makes it relentlessly clear that we cannot have a common currency zone without a common fiscal, economic and social policy.--- Former German Chancellor Gerhard Schroeder

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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