Gold vs. Platinum: Precious Yet Volatile Spread: Understanding How Markets Are Linked Is Key to Trading Intercommodity Spreads Successfully. Here, We Review the Fundamentals That Bind Gold and Platinum

Article excerpt

The simultaneous purchase and sale of different but economically related futures contracts is called an intercommodity spread. This type of spread is employed best if the link between the markets is strong. Often, this means they must belong to the same commodity group, such as soybeans and their products or crude oil and it products. Similarly, it helps if they are interchangeable in use, such as wheat and corn for feed, or be produced from the same raw materials, such as heating oil and gasoline.

Some intercommodity spreads are standardized and are traded on exchanges as separate and individual contracts. Some other spreads, although they still are popular--for instance, platinum and gold--require purchasing and selling separate contracts to create the spread position.

The need to buy different contracts does bring certain inconveniences. You need to concern yourself with issues such as weighting the positions by size, profit/ loss calculations and additional slippage concerns. Despite these logistical hurdles for some types of intercommodity spreads, all types are widely used for both hedging and investment.

Two metals

An exemplary example of these spreads is the aforementioned platinum (PL) and gold (GC).

As a rare precious metal, platinum, alongside palladium, gold and silver, is of interest as an investment. This is obvious in how the metal's price moves, which is similar to that of gold in many respects. "Precious comparison" (right) helps illustrate this.

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Throughout history, fluctuations in the platinum price occurred at the same rate and magnitude as gold's. Prior to the period shown, during 1960 to 1977, platinum prices slowly rose from approximately $100 to $150 per ounce. Between 1977 and 1980, prices surged, reaching almost $1,050 per ounce. They then fell, remaining stable at about $400 until 1999. Starting in 2001, platinum prices experienced a substantial rise that peaked at $2,276 per ounce in March 2008.

However, the rise in platinum prices during this time was not purely because of interest in this metal as a means of investment. As much or more of the rise was caused by the growing requirements of industry, which developed rapidly in 1999-2008. Platinum's substantial dependence on industrial demand is corroborated by a sharp price decline that occurred during the financial crisis of 2008. In that period, prices fell tremendously, from $2,200 to $787 per ounce.

The idea of trading the platinum-gold spread is to profit from shifts in the relationship between gold and platinum prices. The spread is primarily a speculative vehicle, but also has value to hedgers. To purchase this spread, a trader buys platinum futures and sells gold futures. To sell the spread, a trader shorts platinum futures and goes long gold futures.

As with the more popular gold-silver spread, the platinum-gold spread requires correct weighting of the long and short positions. Apart from a rather considerable price difference, the sizes of the underlying futures contracts are different. A gold contract represents 100 ounces, while a platinum contract is 50 ounces. Taking into consideration the current platinum vs. gold price ratio, we can use one platinum futures contract (PL) and six mini-sized gold (10 oz.) futures (MGC) to balance the structure of this spread.

We can calculate the monetary value of the platinum and gold positions using existing market prices on July 7. So, for platinum this will be $1,760 * 50 = $88,000. For gold, it will be $1,580 * 10 * 6 = $94,800. As is clear from these calculations, both values are close enough to consider the spread properly structured. Over time, the proportions may change, so the investor should weigh the positions each time the spread is purchased or sold.

The spread is the difference between the two metals generated by subtracting the gold price from the platinum price (see "Two markets to one," right). …