The stock market outlook for the next 12 months is only moderately positive.
That is the conclusion of a market timing model based on the GC00 gold price ratio,
to platinum PL00,
You might think it’s good news that stocks’ 12-month potential is as promising now as it was in early 2021. But in fact, most stocks have struggled since then. A relatively small number of large-cap stocks have buoyed the S&P 500 SPX,
highest, and the Russell 2000 RUT index,
is 9.2% lower than where it was when My early 2021 column on this gold-platinum relationship was published. The Nasdaq COMP Composite Index,
it is only 1.8% higher, while the Russell Micro-Cap Index is 14.7% lower. (Data, courtesy of FactSet, is through March 28.)
The discovery of the market timing potential of the gold-platinum ratio dates back to a 2019 study in the Journal of Financial Economics. He showed that a rising gold-platinum ratio forecasts higher stock market returns over the next 12 months, and vice versa. Titled “Gold, Platinum and Expected Stock Returns,” its authors are Darien Huang, a former professor of finance at Cornell University, and Mete Kilic, a professor of finance at the University of Southern California.
The chart below shows this gold-platinum ratio over the last 20 years. Note that the ratio declined for many years before and including the 2008 financial crisis, which correctly predicted less upside potential for the stock market. Since 2008, by contrast, the ratio has risen for the most part steadily, as has the stock market.
During the COVID pandemic of the last two years, the ratio has been highly volatile: it spiked in the wake of the cascading market crash in March 2020, anticipating the huge potential of the market over the next 12 months. Since then it fell, rose again and in recent months it has fallen again.
The relationship works, according to the professors, because platinum and gold respond to different factors. While platinum primarily reflects changes in industrial demand, gold responds both to that demand and to investors’ desire to hedge against economic and geopolitical uncertainty. By focusing on the relationship between the price of gold and the price of platinum, it focuses on the part of the gold price that is a hedge against uncertainty. Since the expected return of the stock market is a tradeoff for uncertainty and risk, this ratio should be particularly valuable to market timekeepers.
That is exactly what the teachers found. Since 1975, the gold-platinum ratio has had a significantly better track record in predicting subsequent 12-month market performance than nine other known indicators that other researchers previously found to have predictive ability, including, notably, the adjusted PE ratio cyclically, or CAPE, popularized by Yale University (and Nobel laureate) Robert Shiller.
The ‘war puzzle‘
It may surprise you that the gold-platinum ratio has fallen in recent months, suggesting that the risk has subsided. However, in February Russia invaded Ukraine and, according to some, the conflict could lead to World War III. That certainly sounds like the very definition of elevated risk.
In fact, however, the decline in the gold-platinum ratio in the wake of the Russian invasion of Ukraine is not that unexpected. It’s been known in academic circles for some time that the stock market tends to experience below-average volatility during wars and military conflicts, a pattern known as the “puzzle of war.” According to a study that the National Bureau of Economic Research began circulating a couple of weeks ago, stock market volatility has been “33 percent lower during major wars and periods of conflict since 1921.”
The study, “Stock volatility and the puzzle of war”, was in charge of Gustavo Cortés, finance professor at the University of Florida; Angela Vossmeyer, professor of economics at Claremont McKenna College, and Marc Weidenmier, research associate at Chapman College. They at least partially solved the puzzle and found that increased defense spending during wars and military conflicts makes corporate profits more predictable. That in turn translates into lower stock market volatility and risk.
Regardless of whether this solves the “war puzzle”, the message from the gold-platinum based indicator with a good market timing track record is that the potential for the stock market over the next 12 months is only moderately positive.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at firstname.lastname@example.org