Copper(x2)/Gold Spread: New Multi-Year Lows. What’s the Plan?

Nice Try

The blog entered a long position in the December copper(x2)/gold spread -$18,000 on May 26th.  The position was then liquidated on June 10th at -$25,915 for a loss of -$7,915.

We took a shot at the trade because the spread exhibited the same pattern that occurred at prior major bottoms.  Although it didn’t work out this time around, we still bet with the odds and defined our risk.  Regardless of the outcome, that’s proper trading.

Despite taking a hit on the spread, it is still a candidate for a trade on the long side.

Extreme Lows

The nearest-futures copper(x2)/gold spread breached the -$26k level today.  From here, it wouldn’t take much for it to go ahead and tag major price support at the 2009 all-time low of -$29,380 (premium gold).

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

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

Furthermore, the spread inversion has now lasted for seven months.  It hasn’t stayed under water this long since the 1980s.

Oh, and did I mention that the ratio between the value of one 25,000 lb. copper contract and one 100 oz. gold contract also shrank to a new multi-year low of 0.399:1?  That’s right on the doorstep of the financial crisis low of 0.35:1.

Copper Gold ratio (nearest-futures) weekly

Copper Gold ratio (nearest-futures) weekly

The copper/gold ratio has only been at 0.35:1 or lower on three occasions in the last four decades.  If it sinks into this area again, we may adapt by spreading three copper contracts against one gold contract in order to normalize the position.  And boy, do we hope that happens!  Short-term, when a commodity spread plunges to multi-decade lows it seems like a curse.  Long-term, however, it is recognized as a gift bestowed on traders from the market gods.  Keep a long-term perspective.

What’s It Mean?

It’s crazy to think that the copper(x2)/gold spread is priced almost as bad as it was during the depths of the financial crisis, huh?  The continued under-performance of an industrial metal like copper against a safe-have precious metal like gold is certainly ominous.  Perhaps we should have started the post with “It was a dark and stormy night…

Perhaps this is telling us that the global economy is a lot worse off than the stock market or the Central Banks and economists are letting on…

Perhaps the return of George Soros and his bearish macro wagers is the confirmation…

Perhaps China –the world’s largest copper consumer- is on the edge and about to be pushed off…

However it plays out, the beacon that the IMC blog will continue to follow is price.  If things really are going to hell in a hand basket then we shouldn’t get too many buy signals in the continued bear market.  After all, the December copper(x2)/gold spread has closed below the declining 100-day Moving Average for an entire year straight.

Copper (x2) Gold spread daily (100-day MA)

Copper (x2) Gold spread daily (100-day MA)

But what if this is a capitulation low and a major bottom is being established right now?  We believe that a trend change signal will get us on the long side of the buying opportunity of a lifetime long before it makes any fundamental sense to do so.

Trade Strategy:

Work a hypothetical order to buy two December copper contracts and simultaneously sell one December gold contract on a two-day close above the 100-day MA (currently at -$15,862.50).  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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