Is the Gold-Platinum Ratio Signaling Trouble Ahead for Stocks?

“Gold and platinum are proven stock market predictors. Here’s what they’re saying now.

The gold-platinum ratio has plunged. If this market-timing indicator is correct, stock prices will follow.

The odds of a major decline in the U.S. stock market have just shot up, even as the S&P 500 SPX +0.34% and other U.S. benchmarks are at new highs.
The gold-platinum ratio is a short-term stock-market timing model that with an impressively accurate track record — and it’s just turned bearish.

The indicator looks at the ratio of gold’s GC00 -0.09% price to platinum’s PL00 -1.29%. Ominously, the gold-platinum ratio is posting one of its biggest drops since gold began freely trading in the U.S. in the early 1970s.

According to a 2019 study, “Gold, Platinum and Expected Stock Returns,” the gold-platinum ratio has a better track record when predicting the stock market’s near-term return than most of the other better-known indicators. The study was conducted by Darien Huang, a former finance professor at Cornell University, and Mete Kilic, a finance professor at the University of Southern California.

I last wrote about this ratio in early March. Predictions of a new bear market were then widespread. But because the gold-platinum ratio at the time was in a strong uptrend, followers remained bullish. The S&P 500 has since gained about 8%.

Until two months ago, the ratio was in a consistent uptrend for most of the past several years. Since mid-April, however, platinum has risen more than 40% while gold has been steady to slightly lower, causing the gold-platinum ratio to plummet. That bodes ill for the stock market’s near-term prospects.

The reason the ratio has been a good short-term market timing indicator, according to the study’s authors, is that it’s a sensitive proxy for geopolitical risk. While both gold and platinum have industrial uses and tend to rise when the economy is strong, gold is correlated with geopolitical risk. So when the ratio is falling, the market is sensing that the economy is relatively strong compared with geopolitical risk.

You may find it surprising that a falling ratio suggests the market’s prospects have dimmed. Isn’t it a good thing if the economy is relatively strong compared with geopolitical risk?

To understand the answer to this question, it’s important to distinguish between the ratio as a coincident indicator and as a leading indicator. As the former, it is indeed the case that equities tend to be above-average performers when the ratio is falling. This is what we’ve experienced over the past couple of months.

The opposite is the case for the ratio as a leading indicator. When the ratio is falling, investors are requiring less future return to compensate them for the geopolitical risk that previously was much higher.

There may be some idiosyncratic factors that have caused the gold-platinum ratio to fall as much as it has since April, as my colleague Myra Saefong recently discussed. But, given how much the ratio has fallen over the past two months, it seems unlikely that those factors fully explain the recent returns of gold and platinum. And that suggests the stock market’s prospects over the next several months are significantly lower.”