Copper(x2)/Gold Spread: Trading the Christmas Contracts

Time Marches On

The IMC blog has been waiting patiently for months for the copper(x2)/gold spread to trigger a buy signal.  Currently, we are using a two-day close above the declining 100-day Moving Average to give us the green light to bet that the red metal will outperform the yellow metal.  It hasn’t happened in eleven months now.

Other than the last two days of 2015, the sum of the value of two copper contracts has been worth less than the value of one gold contract for six months straight.  This is the longest inversion since the mid-1980s and beats out the four-month inversion that occurred between late 2008 and early 2009 when the world was mired in the great Financial Crisis.

Pressing On a Wire

Yesterday the nearest-futures copper(x2)/gold spread closed just $995 away from the February 11th multi-year low of -$24,465 (premium gold).  A close below the February low could fast track the market to the 2009 all-time low of -$29,380 (premium gold).  In the futures markets, that’s the sort of move that could happen in just a day’s time.

Copper (x2) Gold spread (nearest-futures) daily

Copper (x2) Gold spread (nearest-futures) daily

Given the stretched duration of the inversion and the extreme lows of the spread, one could argue that everything is being lined up for a major bull run once the trend finally changes.

Extending Our Lease

For the last couple of months, we’ve been monitoring the Sep-Aug copper(x2)/gold spread for an entry signal.  But the December spread is trading at a similar price.  So we are inclined to switch over to stalking the December spread for a trade instead.  It buys us more time.

December Copper (x2) Gold spread daily

December Copper (x2) Gold spread daily

Once the trade is entered, we won’t have to worry about rolling the contracts until we near Thanksgiving!  That’s a lot of time.  We’ll take it!

Future Changes…Maybe

Currently, the ratio between the value of one 25,000 lb. copper contract and one 100 oz. gold contract is near a multi-year low of 0.40:1.  If it continues to sink, it may have a shot at matching the financial crisis low of 0.35:1.  That would certainly be a noteworthy event.  After all, the copper/gold ratio has only reached 0.35:1 or lower on three occasions in the last forty years!

Copper Gold ratio (nearest-futures) monthly

Copper Gold ratio (nearest-futures) monthly

If the ratio does drop down to this area, it would take nearly three copper contracts to equal one gold contract.  If that happens, we may adjust our spread ratio to buy three copper contracts for every one gold contract we sell short.  This would normalize the spread position.

The Trade of a Lifetime?

Think about it: The inversion is already the longest in over three decades and dropping to a ratio of 0.35:1 would be only the fourth occurrence in four decades that it’s been priced that low.  Most likely, that would be accompanied by a test of the all-time low in the spread…or maybe even a new record low!  This is setting the stage for a major macro bet.  Get your financial affairs in order and have a game plan for how you’re gonna trade this spread.  You won’t want to miss this!

Trade Strategy:

Cancel the hypothetical order for the Sep-Aug copper(x2)/gold spread and place a new order to buy two December copper contracts and simultaneously sell one December 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 -$12,700).  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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