Platinum/Gold Spread: Trade and Strategy Update

Platinum/Gold Spread

Turmoil in Greece, the slowest economic growth in decades in China (not to mention the recent stock market crash), and the coming (expected) start of interest hikes in the US have been smashing the precious metals and industrial metals for months on end.

Eroding economic conditions means that car sales will slow down. Since platinum is used in the automotive industry for catalytic convertors, it has dropped even faster than gold. Furthermore, platinum supplies from South Africa have increased markedly since last year. This is all fodder for a continued bear market.

Platinum Gold overlay weekly

Platinum Gold overlay weekly

Currently, platinum has been priced at a discount to gold for a little over six consecutive months. This is the sixth-longest duration that the spread has been below ‘even money’ in the last forty-five years. It is impressive, but the prior inversion periods show that this can stretch out a lot longer.

Prior inversions have lasted nearly seven months (late December 1974 through mid-July 1975), seven and a half months (early December 1980 through late July 1981), ten months (the second half of March 2012 through mid-January 2013), 1-year and 2-months (late June 1984 through late August 1985) and 1-year and 7-months (mid-September 1981 through April 1983).

On July 9th the January 2016-Dcember 2015 platinum/gold spread set a new contract low of -$137.40. On the weekly nearest-futures chart, the low of this decline so far has been -$130.90 (premium gold). Only the 2012 weekly lows posted substantially lower prices of -$212.30 in January 2012 and -$219.80 in August 2012.

The point of all this is that the current size and duration of the decline below ‘even money’ is significant. Although history shows that it has lasted longer and gone lower, we do know that this inversion between platinum and gold prices has always turned out to be a buying opportunity for informed spread traders. There is no reason that this should be any different.

What Will It Take?

To indicate that this near market is over, we would like to see the platinum/gold spread make a two-day close above the declining 75-day Moving Average for the first time in nearly a year. A breakout above a previous month’s high for the first time since March and only the second time during this thirteen-month bear market would alter the bearish price structure and confirm the turnaround. Once this occurs, the bear market should be over and the spread should rocket back above the ‘even money’ mark.

Platinum Gold spread nearest-futures daily (75-day MA)

Platinum Gold spread nearest-futures daily (75-day MA)

Conversely, a close below the July 9th contract low of -$137.40 (premium gold) would keep the platinum/gold spread on course for a return to a double bottom at the nearest-futures record lows at the December 7, 2011 low of -$218.90 and the August 10, 2012 low of -$219.80.

Fully Committed

Normally, we stalk a qualified spread with technical parameters to get positioned on a reversal. Once we’re in, another reversal to new lows in a downtrend or new highs in an uptrend will be our cue to exit stage right with a temporary loss and wait for a new entry signal. It’s nice, neat, simple and logical.

But once in a great while, we see a spread that reaches its lowest or second-lowest level in history. If the spread is between highly-correlated markets with a strong fundamental link, the ratio corroborates the historically extreme reading, and the carry-charge several months out is not unreasonable, then a spread trade position can be treated more like an investment.

To ‘invest’ in a spread, one needs to greatly reduce or even eliminate the leverage. This gives you staying power in the event that the spread continues to move adversely. That way, there is no risk of a deficit or even a margin call on the position.

Our viewpoint is that one side of the spread should be backed with the full value of the contract. Since the other side of the spread is positioned in the opposite direction with a highly correlated market, it acts as a hedge to this unleveraged position.

For example, the January 2016-Dcember 2015 platinum/gold spread closed at an historically low price of -$103.70. If we were to ‘invest’ in this spread we would buy two 50/oz. January platinum contracts at the closing price of $982.30. To do this unleveraged, we would back this position up with $98,230. At the same time, we would short a 100 oz. December 2015 gold contract at $1,086.00 (value of $108,600). This should act as a hedge to the long platinum position. Now we just sit back and wait for the trend reversal. If it doesn’t happen by the first notice day for the December gold contract, we simply roll to the further out spreads.

Stepping On the Accelerator

Somewhere down the road, there will be a time to increase the leverage on the investment position. After all, you should want to maximize the profit opportunity of holding a spread that’s entered in the right direction at a price that’s rarely seen. That will happen if/when the position is showing a healthy open profit that can cushion a drawdown on an additional spread.

Note, however, that this additional spread will require an exit parameter in the event that it moves too far against you. This is because it is a leveraged position.

The strategy requires some patience, but the payoff can be well worth it. There are hedge funds, CTAs, famous traders, etc. that have built their fortunes and substantially outperformed the market benchmarks using this sort of strategy. So it certainly makes sense that an individual trader/investor should explore this method.

Trade Strategy:

Cancel the current hypothetical order in the October platinum/gold spread. The IMC blog will now work the following trade entry contingencies. Take whichever one is elected first as the signal to get long:

  1. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread makes a two-day close above the declining 75-day MA (currently around -$79.40). If filled, the initial liquidation plan is to exit on a two-consecutive day close $5/oz. below the contract low that precedes the entry (currently at -$137.40).
  2. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread closes above the July 2nd bounce high of -$80.40. If filled, the initial liquidation plan is to exit on a two-consecutive day close $5/oz. below the contract low that precedes the entry (currently at -$137.40).

Investment Strategy:

In addition, we will now work the following three ‘investment’ entry contingencies. Take whichever one is elected first:

  1. Sell one 100 oz. December 2015 gold contract at $1,000.00 on a GTC stop order. If filled, immediately buy two 50/oz. January platinum contracts at-the-market. Initially, there will be no liquidation parameters for this low-leverage position.
  2. Buy two 50/oz. January platinum contracts at $775.00 on a GTC limit order. If filled, immediately sell one 100 oz. December 2015 gold contract at-the-market. Initially, there will be no liquidation parameters for this low-leverage position.
  3. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread trades to -$200.00. Initially, there will be no liquidation parameters for this low-leverage position.

 

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