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How to Profit From the Metal That's More Precious Than Gold - Outside View

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How to Profit From the Metal That's More Precious Than Gold
Oct 1, 2010

Gold set another new record on Wednesday, closing above $1,300 an ounce for the second-straight day. The London Bullion Market Association - at its annual conference this week - projected that the "yellow metal" would advance to $1,450 in the next year.

With the U.S. Federal Reserve, the Bank of England (BOE) and the Bank of Japan (BOJ) all having near-zero interest rates and moving toward more "quantitative easing" - pumping money into the global economy - the case for gold looks more convincing than ever.

Yet there are other precious metals that stand to benefit from the same inflation-hedging-related demand that's driving gold to record after record.

One particular metal right now looks to be an even better investment than gold. It is favored by Chinese investors and is benefiting from soaring industrial demand. Unlike gold or silver, this particular precious metal has risen only about 6% this year, and remains well below its 2007 peak.

The metal I'm talking about is platinum.

Platinum's Promise

Platinum is extremely rare, occurring at only 0.003 parts per billion (ppb) in the Earth's crust. This makes it the most precious of all precious metals - about 30 times rarer than gold. Annual platinum production is roughly 175 tons, equal to 6% of the annual production of gold. In fact, platinum is so rare that if all the platinum in the world were poured into one Olympic-size swimming pool, it would scarcely be deep enough to cover your ankles. At the same time, unlike gold, platinum has major industrial uses, most notably in automobile catalytic converters.

Platinum is by far the best metallic catalyst. Since the 1980s, this "noble metal" has been used in catalytic converters, which oxidize toxic carbon monoxide into carbon dioxide, and toxic hydrocarbon fractions to carbon dioxide and water.

Its usage, therefore, is closely tied to automobile demand.

Platinum's principal competitor is palladium, which is cheaper, but considerably less effective. So the pricing of the two metals tends to move in parallel, with platinum being three-times to four-times as expensive as palladium. This year, however, palladium prices are up more than 35%, bringing the platinum/palladium price ratio down to an exceptionally low level around 2.5.

Needless to say, the principal market for automobile catalysts today is China, whose automobile market last year leapfrogged its U.S. counterpart to become the largest in the world, and where sales in August were running about 18% ahead of its 2009 totals.

Although Chinese automobiles use less fuel than the larger U.S. cars, they use just as much catalyst. In the last year or so, Chinese manufacturers have tended to use palladium catalysts, while Europe uses platinum. But rising global auto demand and the two metals' recent convergence in price has made platinum relatively more attractive.

Thus, platinum demand, driven by the worldwide automobile industry - including a certain amount of the rapidly growing Chinese and Indian auto sectors - can be expected to display continued strength.

An additional attraction of platinum is strong demand from investors in China. To the extent that they're permitted to buy them, that country's investors are keen on precious metals in general. In the case of platinum, demand takes the form of platinum jewellery, whose sales in China rose from a 2008 level of 1.06 million ounces to a 2009 all-time record of 2.08 million ounces - an amount equal to about 35% of the world's platinum mine output of 5.9 million ounces.

Since annual catalyst demand is estimated to run at 50% of world platinum output, it's easy to see the potential for a supply/demand imbalance and a jump in platinum prices.

The Search for Suppliers

More than 80% of the world's platinum is mined from South Africa and Zimbabwe, neither of them known for efficient mining techniques or secure property rights. Another 10% comes from Russia (enough said!).

That makes investment in a platinum mine rather unattractive. There is one decent-sized North American mining company in the field, Stillwater Mining Co., which mines both platinum and palladium in Montana. But Stillwater shares are currently trading at about 67 times earnings - scarcity value will do that!

Indeed, analysts at the London Bullion Market conference just predicted that platinum prices would advance 15% next year, but those conferees are often overly cautious (last year, for instance, they predicted that gold prices would be at only $1,182 today). So this precious metal should provide investors with a handsome return in the New Year.

Action to Take: Given the risk facing overseas platinum miners and the stratospheric valuations of North American platinum miner Stillwater Mining Co. (NYSE: SWC), it's clear that the best route into platinum is the metal itself. That means it's time to look at an exchange-traded fund (ETF) - the ETFS Physical Platinum Shares (NYSE: PPLT).

PPLT has only been around since January, but it has a relatively low 0.60% expense ratio. In June, the size of PPLT exceeded its authorized maximum of 4.78 million shares (about $750 million at current prices), so it's already large enough to be plenty liquid.

This article is authored by Martin Hutchinson. Martin is a Contributing Writer for Money Morning and had predicted the record run in gold back in October 2007 when it was trading at less than US$ 770 an ounce.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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