Think the rally is safe? This elite market-timing indicator says a correction is overdue.

The U.S. stock market’s prospects continue to deteriorate, according to the gold-platinum ratio — a relatively obscure indicator with an impressive track record predicting the stock market’s 12-month return.

I say “continue” because the ratio of gold GC00 to platinum PL00 was already declining when I last wrote about it in November. As you can see from the accompanying chart, the ratio has declined since then. That doesn’t bode well for the S&P 500 SPX.

The market-timing potential of the gold-platinum ratio was first reported in the Journal of Financial Economics in a study entitled “Gold, platinum and expected stock returns.” The authors found that the ratio “outperforms nearly all existing return predictors” when predicting the stock market’s return over the subsequent 12 months.

The researchers based this conclusion after analyzing data from 1975 to 2013. The accompanying chart, reflecting data since 2014, constitutes an out-of-sample test of their conclusion. Though the ratio isn’t a perfect predictor of the stock market’s subsequent 12-month return, it has done a creditable job since 2014. It did particularly well navigating the COVID-19-induced bear market in 2020 and subsequent recovery, for example.

The reasons that the gold-platinum ratio is a good market-timing indicator, according to the study, are that the two metals respond to different factors. While both are correlated with the economy, gold — but not platinum — also reflects geopolitical risk and uncertainty. A rising ratio means that geopolitical risk is growing, and when that happens, stock investors will demand a higher expected return to compensate them for that risk. That causes the stock market to fall as the ratio is rising, but to have higher returns in subsequent months.

To put the researchers’ argument another way, as a coincident indicator, the ratio is inversely correlated with the stock market. But as a leading indicator, it is positively correlated.

You may have a hard time believing that the gold-platinum ratio is falling because geopolitical risk is receding. But this narrative is not as far-fetched as it otherwise might appear. Consider a geopolitical risk index (GPR) created by Federal Reserve economists Dario Caldara and Matteo Iacoviello. It’s a news-based index that measures “the threat, realization and escalation of adverse events associated with wars, terrorism and any tensions among states and political actors that affect the peaceful course of international relations.”