Monday, August 28, 2017

Platinum Undervalued Relative To Gold, Decent Mean Reversion Play

Platinum (PPLT) to gold (GLD) ratios show wide variance over the years

Since 1971 the average price ratio of Platinum/Gold has been 1.23:1

The current ratio is .75:1 which represents a mean reversion opportunity

Small processor of mine tailings a unique way to take advantage of rising platinum price


The chart above shows the last 40 years platinum to gold ratio. As can be seen the platinum price usually trades at a premium to the gold price. In fact in the last forty plus years the ratio has only traded this low once before back in 1982.

The chart above shows the platinum to gold ratio distribution over the last forty five years. Take a look at the left side of the chart. The current ratio is trading at a historical extreme that is only seen for less than 5% of the time.

Okay but past performance is no guarantee of future returns. I agree but trading and investing is about putting the odds in ones favor. I believe the ratio will return to its historical norm and more than likely overshoot to the upside.

How to play this setup 

If you are a buyer of actual precious metals you could just go out and buy physical platinum or the platinum ETF. One could also do a pair trade and go long platinum and short an equal dollar amount of gold and capture the difference as the ratio returns to historical norms. Returns could be enhanced by using leverage via futures or options.

An investor could take a look at buying miners like Impala Platinum (OTCQX:IMPUY), Norlisk Nickel (OTCPK:NILSY) although platinum group metals (platinum, palladium, rhodium) are only one part of Norlisk's operations and are a by-product of it's primary nickel mining operations.

I am playing this by buying shares in a speculative platinum and palladium producer in South Africa called Sylvania Platinum (OTC:SAPLF) which also trades on AIM London Exchange (SLP). This company is not really a mining company as it is more like a mine waste processor.

The company owns dump operations that it acquired from other mining companies primarily chrome producers. These dump operations are basically huge piles of dirt left over from the primary mine. However the leftover spoils contain commercial quantities of platinum and palladium.

The company basically uses large water jets that create a slurry that is then transported via pipeline to a processing plant where the pgms's are extracted. The process can be viewed on the company website.

Sylvania recently reported earnings for FY 2017 and they were outstanding in every way:

PGM production up 17% to over 70k ounces per year

Revenue up 28%

EBITDA of $18MM up 65%

Profit after tax of $8.9 MM up 138%

Basic eps of 3.06 cents up 139% which puts the P/E at around 4.8

I think pgm prices are heading higher as platinum has been in a supply/demand deficit for several years. Although electric cars sales are growing in the west, emerging markets are still going to be purchasing cars with internal combustion engines. The emissions from the huge growth in the sales of these cars is leading to stiffer emission rules which means higher pgm use.

What could go wrong?

The company is based in South Africa and this has benefited the company as the Rand depreciates against the dollar. The depreciation is due to the political risk which is not going away anytime soon. There have been rumblings about black empowerment schemes and nationalization.

PGM  prices could weaken, however we are now experiencing global synchronized economic growth for the first time in eight years. In addition, we are exiting a five year bear market in commodities. The price to the downside is limited in my view.

Mine issue and issues with the processing plant. The management has been successfully running these operations for many years. Although always a risk in mining and processing I view it as a small one.

Electric cars displacing ICE's. Might happen, could happen, but that appears a more long term risk (5-10 years) and not in the timeframe (1-2 years) that I will be anticipating this company's shares to run up.

If one is interested in buying a position I would trade it in London as the liquidity is better than the pink sheet quotes in the US.

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