The Platinum / Gold Spread ..... more than just a pet market

Thursday 18th February 2016

The Platinum / Gold Spread..... more than just a pet market

ref :- General

Many traders have their favoured markets, ones that they particularly like to follow that may or may not fall strictly within their brief. Sometimes they like a particular market just because they have a decent track record in it..... well, it does help. Anyway, one such market is the Platinum/ Gold Spread, which may seem natural enough for metals traders or those involved in commodities more generally, but has attracted a wider following due to what it may tell us about the broader global economy.... and besides that, it's kinda neat.

At their most simple, these spread trades involve buying one and selling the other of two, related commodities. You could equally be talking about the Corn/ Wheat Spread, or even the 2yr Treasury Note against its 10yr equivalent. One of the attractions of spread trading is that you are not required to take a fundamental, directional view of the complex as a whole (in this case precious metals), rather you are trading the Differential between the two commodities. In theory it doesn't matter to you whether prices go up or down, it's all about how one commodity performs in comparison to the other. If that sounds to you like a nice, safer way to trade then we would urge you to be very careful: In March 2008, a spike in Platinum prices caused by power outages at South African mines saw Platinum trade at a previously unthinkable $1290 per oz ABOVE Gold. Last week, it traded $285 BELOW the yellow metal, an historic low.

To put that in context:  For one single futures contract (actually one 100oz Gold futures contract versus two 50 oz Platinum futures contracts), that's a movement of $157,500. Now, we realise that's a long time frame and that we're picking the ultimate extremes but you get the point.... if you get the wrong side of any chunk of that kind of move then you will NOT be thinking that this spread trading lark is anything like risk-averse.

Anyway, some facts: Gold is mined in a wide variety of areas across the globe; the vast majority of Platinum comes from just two countries: Russia and South Africa, which alone produces nearly three-quarters of the total. It is estimated that Platinum, in terms of what has already been mined and what is thought to be in the ground, is fifteen times rarer than Gold. It's not surprising therefore that Platinum has historically commanded a premium over Gold --  over the last thirty years, it has traded higher by an average of about $200 per oz. There have been odd occasions before when the price of Platinum has fallen below that of Gold, notably 2012/13, but these have tended to be brief inversions before what might seem its rightful premium is restored. (Another caveat: in this context, brief can mean a year or more).

So what moves the spread? Like all commodities the prices of the two metals are subject to the basic laws of supply and demand so moves like that of March 2008 mentioned above are always a possibility. But all things being equal, what else drives it and why has Gold gone to a record premium over Platinum? They're both precious metals, aren't they? Well, yes they are..... but Platinum is also an industrial metal, and there's the rub. Whilst Gold has very limited practical uses (as jewellery and as a store of value), Platinum's role as an industrial metal means it reflects global economic health far more closely. About a quarter of the world's Platinum production ends up in China, and the much-trumpeted slowdown in Chinese growth has been a body blow. Perhaps even more relevant is Platinum's function in catalytic converters, which make diesel car emissions safe (or should do!). About a third of global production is used for this purpose. Diesel engines were already beginning to run out of favour in many parts of the world but the VW scandal has hugely compounded the problem. And on Gold's side of the equation, its status as a safe-haven in times of stress and market turmoil has boosted prices to the extent that it's the best-performing commodity in 2016 so far. In fact, you could say that what's been good for Gold is part of the same thing that's been bad for Platinum.

So there are reasons why the spread has moved the way it has, but Platinum $285 under Gold? Too much, surely? Is it time to Buy Platinum/ Sell Gold and watch things revert closer to longer-term norms? With the spread trading at about $265 as we write, some are already suggesting that a base has been established, which may be a little premature given the scant evidence and may be a call influenced by the "How low can it go?" school of thinking. If you put Platinum/ Gold Spread into Google, it's fascinating how many brokers have put out Buy Plat/ Sell Gold recommendations all the way down from parity to where we are now. The more uncouth traders have a pretty unsavoury expression about those who try to pick bottoms in market moves which we won't repeat here.... suffice to say, it's a dangerous business.

The thing to remember is that just because something is particularly low doesn't mean it can't go lower. It may be something of a non sequitur but we can't help being reminded of those who not so long ago were asking the question: "Why on earth would you buy a bond with negative yield?" . And the answer is of course because yields can go even more negative (and therefore prices even higher). We'll be watching, and wishing good luck to those brokers hanging on in the hope that Platinum is about to do some major catching up. Who knows? Gold might well lose its allure, growth might pick up and boost Platinum. There may even be a repeat of strikes in South Africa that periodically give the white metal a lift. That's the thing with spreads, you can be right for any number of reasons, none of which is the reason you dealt in the first place.