Copper(x2)/Gold Spread: Still a Screaming Bargain!

Still Underwater

We have been stalking the spread between copper and gold for a signal to get long.

With the exception of a two-day excursion on the last two days of 2015, the value of two copper contracts has been priced at a discount to the value of one gold contract for the last four months. That’s about how long the inversion lasted during the depths of the financial crisis between late 2008 and the first quarter of 2009.

If this carries on a few more weeks, it will be the longest inversion since the mid-1980s.

Deep Dive

Back on February 11th, the nearest-futures copper(x2)/gold spread hit a multi-year low of -$24,465 (premium gold). This put it within striking distance of the all-time low from 2009 at -$29,380 (premium gold).

Furthermore, the ratio between the value of one 25,000 lb. copper contract and one 100 oz. gold contract also hit a new multi-year low of 0.40:1.

Both the spread and the ratio have been on the rebound for the last month. However, it has not yet signaled a trend change and given us the green light to get long.

If the rally fizzles out and the ratio heads even lower to return to the financial crisis low of 0.35:1, we will likely adjust our spread position composition to trading three copper contracts for every one gold contract. This would be done to normalize the position.

We certainly hope that we get the chance to do this! After all, the copper/gold ratio has only been as low as 0.35:1 three times in the last four decades.

Each time turned out to be a phenomenal buying opportunity.

Trigger Point

Currently, for our signal to get back in on the long side of the copper(x2)/gold spread, we are waiting for a two-day close above the declining 100-day Moving Average. It’s now been nine months since that last happened.

Sep-Aug Copper (x2) Gold spread daily

Sep-Aug Copper (x2) Gold spread daily

The last three bounces ended in early September, early November, and late December…just as the spread was nearing the 100-day MA. So a two-day close above the 100-day MA would be a very constructive event.

Since we’re now in the middle of March, we are going to start following the later-dated futures contracts for our trade. We’ve decided on the September copper and August gold contracts. The difference between the Sep-Aug spread and the May-June spread is not that much in the grand scheme of things, so we’re going to take advantage of it.

Trade Strategy:

Cancel the hypothetical order for the May-June copper(x2)/gold spread and place a new order to buy two September copper contracts and simultaneously sell one August gold contract if the spread between the value of the sum of two 25,000 lb. copper contracts and the value of one 100 oz. gold contract makes a two-day close above the 100-day MA (currently around -$6,625). Initially, the spread should be liquidated on a two-consecutive day close $500 below the contract low that precedes the entry.

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