Gold vs. Platinum: Precious Yet Volatile Spread

By Perchanok, Kirill | Futures (Cedar Falls, IA), November 2011 | Go to article overview

Gold vs. Platinum: Precious Yet Volatile Spread


Perchanok, Kirill, Futures (Cedar Falls, IA)


TRADING TECHNIQUES

Understanding how markets are linked is key to trading intercommodity spreads successfully. Here, we review the fundamentals that bind gold and platinum.

The simultaneous purchase and sale of different but economically related futures contraccs is called an incercommodity spread. This type of spread is employed best if che link becween che 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.

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 subscantial 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 che relationship becween gold and platinum prices. The spread is primarily a speculative vehicle, but also has value to hedgers. To purchase chis spread, a trader buys platinum fucures and sells gold fucures. To sell che 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. Apare 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 ratioj 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. So3 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 Co consider the spread properly scruccured. Over cime, che proportions may change, so che invescor should weigh che posicions each cime the spread is purchased or sold. …

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