Platinum/Gold Spread: Current Observations

Taking a Beating

A year and a half ago, the platinum/gold spread inverted. Historically, platinum has never stayed priced below gold.  It’s always been a good buying opportunity.  So the IMC blog jumped at the chance to buy.

As readers know, we’ve been in and out of this spread a few times over the last few years.  It feels like we’ve done nothing but get beat like a proverbial “rented mule” whenever we’ve bought the breakouts in the platinum/gold spread.  Despite the abuse, we are still fully expectant that the platinum will once again trade at a premium of gold.

Platinum Gold spread (nearest-futures) monthly

Platinum Gold spread (nearest-futures) monthly

It is important to remember that commodity spreads are mean-reverting.  History shows that the more extreme a trend gets –both in terms of price and time- the bigger the inevitable reversal.  This current bear market is certainly one of the most extreme that the platinum/gold spread has ever experienced.  Just take a look at the current stats:

-On June27th the nearest-futures platinum/gold spread closed at -$343.30 (premium gold).  This was a new all-time low.

-On June27th the nearest-futures platinum/gold ratio matched the January 20th low of 0.74:1.  This is the lowest that the ratio has been since 1982.

-The spread inversion has now lasted for one year and six months.  If the platinum/gold spread doesn’t rally over $231/oz. in the next four weeks, this duration will tie with the record inversion of one year and seven months that occurred from September 1981 and April 1983.

Moving the Moving Averages

In the spring of 2015, we used a breakout above the declining 50-day Moving Average as a trend change signal to enter long positions in the platinum/gold spread.  That didn’t work out so well.

Then we slowed things down and changed the parameters for our trend change signal to a breakout above the declining 75-day Moving Average.  The spread did not comply with this criterion, either.

After the 75-day MA sucker-punched us at the start of this year, we backed off even more and went with the declining 100-day Moving Average as the new standard.  Three months ago, the platinum/gold spread made a two-day close above the 100-day MA for the first time since the summer of 2014.  For the next few weeks, it looked as though our third moving average parameter was the right pick.  The third time was really the charm!

Well, that idea went to hell in a handbasket.  The spread crashed in the second half of June and knocked out the speculative positions with a loss.

Schools of Thought

Right now, when it comes to the platinum/gold spread, there are two opposing philosophies competing for our loyalty.  This first can be summed up with such clichés as “Staying the course”, “Sticking to our guns”, “Winners never quit”, “Always follow the system”, etc.  This school of thought would have us continue to take buy signals in the spread without pause and without question.

The second philosophy is summed up by phrases like “You got to know when to fold ‘em”, “It’s different this time”, “Doing the same thing over and over and expecting different results is the definition of insanity”, “Know when to pull the plug”, etc.  This school of thought tells us to abandon the idea of buying this spread since it has not yet worked out profitably over the last year and change.

The thing is, I don’t think this has to be a binary Yes or No decision.  My thinking is that we can stay the course by continuing to look for buying opportunities/signals.  After all, the history of mean reversion is on our side.  And it’s not like the ratio hasn’t been this low before and the inversion hasn’t lasted this long.  Even if the ratio and duration of the inversion posts new records, the mean reversion idea argues that a reversal is all the more likely.

At the same time, we can drop the signals that are not giving us the results we want and either adjusts the parameters or even use different trade signals altogether.

This is actually what the blog has been doing all along.  We have slowed the moving average parameters after each signal failure.  I offer the analogy that it’s akin to tuning in the dial to get the exact frequency of a radio station.  If the 50-day MA is giving us “static”, then we use the 75-day MA, if the 75-day MA still doesn’t provide a clear signal, we switch to the 100-day MA, and so forth.

Parameter Recalibration

Since the 100-day Moving Average failed us on the last go around, we are now going to cut the speed of the moving average in half.  This means we are now going to use the widely-followed 200-day Moving Average to tell us what the trend is.

Legendary trader Paul Tudor Jones said, “My metric for everything I look at is the 200-day moving average of closing prices.”

This multi-billionaire made his fortune from trading commodities.  So hopefully looking at one of PTJ’s favorite metrics to determine the trend means that we’re in good company here!

Platinum Gold spread (nearest-futures) daily with 200-day MA

Platinum Gold spread (nearest-futures) daily with 200-day MA

On the nearest-futures daily chart, the platinum/gold spread made a two-month rally into the first half of May.  The rally ended after the spread tapped the 200-day MA and backed off.

Last week the spread finally made a two-day close above the 200-day MA for the first time in exactly twenty-three months.  So maybe…just maybe…this is the real deal?!

We’ve been burned a time or three by chasing the breakouts above various moving averages in the platinum/gold spread.  Not by a breakout above the 200-day MA, though.

However, the spread has already rallied $112/oz. over the last three weeks.  The last time it rallied anything close to this was the $107/oz. rally off the early March low.  And that one took two months to play out.  So it’s feasible that the spread has run a little too far, a little too fast.  It may be vulnerable to a pullback.

Ratio Development

It was mentioned earlier that the nearest-futures platinum/gold ratio matched the January 20th low of 0.74:1 in late June.  Now that it is closing in on 0.83:1, it appears that a double bottom is being established between the January 20th low of 0.74:1 and the June 27th low of 0.74:1.  All it needs now is a close above the May 2nd high of 0.84:1 to confirm it.

Platinum Gold ratio (nearest-futures) daily

Platinum Gold ratio (nearest-futures) daily

As an interesting observation, a double bottom in the ratio to mark the end of the two-year bear market would be the mirror image of the double top in the ratio that marked the start of the bear market.  Furthermore, the double top was established in January and June of 2014, while the current double bottom was established in January and June of 2016.  How cool is that?!

We Can Dream

An ideal scenario would be for the platinum/gold spread to clear price resistance at the early May 5th multi-month high of -$208.50 and then make a pullback near that level and hold.  It may offer an attractive enough reward-to-risk ratio to take a shot at it on the pullback.  If it works out, the position could even be quickly pyramided by adding on a breakout above the high that precedes the pullback.

Now that the important 200-day MA has finally been surpassed…and the three-week run looks extended at the same time…we will vigilantly monitor how the situation unfolds.

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