Gold and Palladium Shake Hands / Commodities / Gold and Silver 2018

The price of palladiumjust exceeded the price of gold for the first time in 16 years. That’s an epiceven. But what does it really mean? And why should gold, silver, and miningstock investors care about the small palladium market?

In short, because thisdevelopment can tell us something about the future performance of the PM sectorin general.

The last time the goldto palladium ratio was trading below 1,meaning that palladium was worth more than gold, was in late 2002. The ratiostayed there for a few months before finally rallying above it, which suggeststhat investors may need to see both metals at similar price levels before theyaccept that palladium can really be worth more than gold. The 2002 example,however, shows that the 1 level works as resistance for the ratio, and in thecurrent case it’s critical to check if it works as support.

And it does. Not with perfectprecision, but it’s definitely useful. Back in 1998, when the ratio wasbreaking below 1, it moved back and forth around this level for several months,and declined below this important level only after this consolidation wascompleted.

What does it imply forthe current situation? It indicates that palladium’smarch higher may stop for a while. Moreover, if gold declines in the followingweeks, it may decline as well in order to keep the ratio close to 1.

The key question thatyou are probably asking yourself is why does this small market (the sizeof the palladium market is tiny compared to the one of gold) matter for those, who are interested ingold, silver, and mining stocks, not only in palladium. The reply is that, whenapproached carefully, palladium’s link to gold can serve as a technical signal.

The gold to palladiumratio by itself is not range-bound. It moves extremes that are not necessarilyconsistent over time and because of that it’s not really useful on its own.However, applying an indicator that would transform the ratio movement intosomething that’s more range-bound can provide us with more valuableinformation. We’ll use the RSI indicator, which you can see in the upper partof the above chart.

Let’s start with thelimitation of the above approach. Even in case of the RSI indicator, theoverbought levels of the gold to palladium ratio are not consistent with eachother (the ratio does not reverse after reaching the same level), which makesit a poor signal for detecting extremes. On a side note, the goldand silver CoT reports have the same flaw.

Fortunately, there is away to use the above after all. The oversold levels of the gold to palladiumratio have shown more consistency and serve as a bearish signal for gold. It'snot clear enough to rely solely on it while making investment decisions, but itappears very useful as a confirmation tool. In the past decade, the RSI basedon the ratio below or very near 30 has been a very reliable indication that abig decline in gold may be just around the corner. The 2009, late-2010,early-2013, late-2016, early 2018 tops were all accompanied by this signal. Themid-2014 was an exception from the rule.

Since almost all casesform the past decade when the RSI based on the gold to palladium ratio movedvery close to or below 30 meant that huge declines in gold are close, then we can view it as a very bearish signal.This is especially the case that it’s not a single bearish factor that’scurrently in place. Conversely, there’s been a numberof factors pointing to a big decline in the prices of gold, silver and mining stocks in the followingweeks. Consequently, the above-mentioned bearish signal serves as theirconfirmation.

From the gold& silver portfolio management point of view, it may be tempting to focus on palladium as it’s beenperforming so well lately. However, the long-term outlook is not as rosy as itseems. We explained it in the part 5 of our Preparing for the Bottom series,entitled Whatto Buy, and it seems that inlight of what’s happening in palladium prices right now, it’s worth quotingthis analysis:

Well, it’s potentialseems more promising than the one of platinum (and the platinumto paladium ratio has been decliningaccordingly), but it’s still likely to suffer due to the same fundamentalreasons in the coming years. Almost 85% of demand for palladium comes from theautomotive industry (it’s used instead of platinum in the case of thegasoline-powered cars), which makes it effectively an industrial metal, moresimilar to copper than to gold. So, should it really be a part of a preciousmetals portfolio? It could, if it had a promising outlook and this also seemsto be a problem. While it’s likely to outperform platinum (just as gasolinecars are taking over diesel cars), it has a major problem in the form ofthe long-termrise of the electric car market share. These cars will not dominate the market shortly, but thetrend is already present and since markets are generally forward-looking, theprices could reflect this trend much sooner, which doesn’t bode well for theprices of palladium in the following years (at least compared to gold andsilver). Some might say that fuel cells will support the demand for platinumand palladium, but thatdoesn’t seem to be the case.

From a technical pointof view, we see that palladium has been outperforming the precious metalssector for a few years, but the 2000 – 2009 performance was very weak. Thebiggest run-up – in addition to the current one – was seen right after the 2008bottom ($160.30) when palladium rallied to $862 in 2011 (rallying by almost438%). For comparison, silver soared from $8.40 to $49.83 (rallying by over493%) – the latter still outperformed. 

So, when did palladiumexactly outperform? When the precious metals sector – in general – was declining.It’s no wonder that this happened – after all, the general stock market hasbeen soaring and the vast majority of demand for palladium is of industrialnature. 

Since we want to enterthe precious metals market and exit it close to the top, then it’s theperformance during upswings that is most important, but one can say that theabove is at least “interesting” about palladium.

What’s less interestingis palladium’s performance in the previous great bull market that we saw 4decades ago. Palladium rose from below $40 to about $350, while gold moved frombelow $40 to about $850 and silver moved from below $1.50 to about $50.Palladium was a clear loser in that race and since history tends to rhyme, itdoesn’t make us thrilled about palladium’s future performance.

All in all, even thoughthe price is currently well above the palladiumproduction cost, this precious metalsdoesn’t seem to be a long-term winner. Its fundamental picture and the analogyto the previous great bull market make us reluctant to include it in the long-term investment category of the preciousmetals portfolio. There are betterways to gain the edge over other investors than through adding palladium to one’sinvestment portfolio.

Summing up, the outlookfor the precious metals market remains very bearish for the following weeks and.The strongly bearish analogies to 2013 and 1999, miners’ underperformance, thenumber of intraday reversals in the GLD ETF, the triangle-based reversals ingold and silver, the outlook for the USD Index as well as the situation in thegold to palladium ratio are only severalof multiple reasons pointing to much lower precious metals’ prices in the nearfuture.

Naturally,the above is up-to-date at the moment of publishing it and the situation may –and is likely to – change in the future. If you’d like to receive follow-ups tothe above analysis (including the intraday ones, when things get hot), weinvite you subscribe to our Gold &Silver Trading Alerts today.

Thank you.

Przemyslaw Radomski, CFA

Founder, Editor-in-chief

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