Will the Metals Test Your Mettle?
Back in late July, we posted a strategy for ‘investing’ in the platinum/gold spread with low or no leverage if it were to drop to historic extremes. With this strategy, we advocate backing it with the full value of the most expensive contract in the spread.
The parameters for the investment strategy were elected today when the January 2016-December 2015 platinum/gold spread dropped to -$200.00 (premium gold). The blog hypothetically purchased two 50/oz. January platinum contracts at $930.80 and simultaneously sold one 100 oz. December 2015 gold contract at $1,130.80.
This investment position is backed with approximately $113k since that is the value of 100 oz. of gold (the most expensive side of the spread). Initially, there are no liquidation parameters for this low-leverage position. Therefore, an investor should have at least in $113k in their trading account to weather any storms and avoid margin calls.
At a price of -$200.00, the platinum/gold spread is at the second-lowest price in history. The spread has now been inverted since mid-January. This eight-month stretch is the fourth-longest duration of inversion in the last forty-five years. As we’ve discussed in previous posts, this is unsustainable and a quick glance at a forty-year price chart makes it clear that buying at these levels are rare events. Ergo, the ‘investment’ strategy for the spread.
In addition to the historically low spread price, the ratio between platinum and gold dropped to a thirty year low of 0.82:1.
In the last four decades, only a two-month period between August and October 1982 ever experienced a lower ratio than todays. This confirms that the current level should be a temporary outlier. Investors and traders armed with this knowledge really have an edge to exploit here.
Upping the Ante
For investors who are willing to take the risk, it makes sense to increase the position once the initial investment is showing a profit. If the bullish trend change signal the blog is using for the entry signal is elected, it would be a logical time to add to investment.
However, since the ‘add-on’ position would increase the leverage factor, investors should give it a shorter leash than a trader might for an exit. Failure to keep the upside momentum after a trend change would be a good reason for investors to at abandon the ‘add-on’ spread and cut the leverage back. You don’t want to see your staying power erode for the initial investment.
Historically, many hedge funds, CTAs, famous traders, etc. earned their fame and fortune by nailing a major event. Counter-intuitively, it was accomplished by not diversifying. It demanded all of their focus. It required a significant amount of their capital. In some cases, it also tied up years of their time. This took patience, confidence, excellent money management, and the guts to stick to the plan. Weakness in any of these attributes could spell financial disaster.
This sort of campaign trading and investing is certainly not for everyone. As a matter of fact, we strongly believe that the majority of people who trade or invest in the markets shouldn’t even think about it! But those select few that are cut from the same risk-taking cloth as the greats (Jesse Livermore, George Soros, Paul Tudor Jones, etc.) may have an opportunity here in the platinum/gold spread. We hope to read about you in the next Market Wizards book.
The IMC blog is currently working a hypothetical order to 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 -$121.00) or a one-day close above the September 3rd high of -$114.00, whichever occurs first. 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.
Hold the long January 2016-December 2015 platinum/gold spread entered at -$200.00. Currently, there are no liquidation parameters for this low-leverage position.
Double the position size if the spread makes a two-day close above the declining 75-day MA. If filled, liquidate the ‘add-on’ position if the spread makes a on a two-day close below the declining 75-day MA.