Trading Extremes in Gold Ratios
Monday, 11/10/2014 20:23
One way to make money trading commodities...
ANDY HECHT is author of
How to Make Money with Commodities and radio show host on financial station online TFNN's
Commodities Hour.
Here he speaks to Mike Norman of Hard Assets Investor about the outlook for gold and silver prices, trading gold ratios, and what's going on in oil.
Hard Assets Investor: Andy, you have a long career in commodities. How does a trader make money with commodities?
Andy Hecht: All of us have an innate understanding of commodity markets. We buy bread, that's wheat. We fill up our automobiles with gasoline once a week. So we understand prices. And these things trade. And we have investments, we have 401(k)s, we buy stocks, we trade currencies, all kind of bonds, fixed income. And commodity prices actually affect all of these assets. So it's very important that people, even if they don't trade commodities, have an understanding of commodities.
Because look, you take a stock like Walmart, they bring products to market. They use fuel. That affects the price of the stock. So we have to understand what the commodity markets are telling us.
Hard Assets Investor: And you're basically saying that most people have an understanding already because we go to the grocery story, we fill our cars up with gasoline, so we have an understanding of price levels. We know when things maybe get too high, and when things are a bargain. And they should incorporate that into their investment thinking process.
Andy Hecht: Calculus – exactly. And when we look at commodities, the commodity markets are the futures markets. But they're also very big physical markets. In the book, what I try to do is explain the physical markets, how they work, who are the biggest producers in the world? Who are the consumers in the world? And how does that all filter into the derivatives market, which is the futures market, which for the braver of heart can do quite well in it if they have a good understanding of how these markets operate.
Hard Assets Investor: Now speaking of understanding, very few people probably would have your level. You worked with one of the premier commodity trading companies in the world back in the day, Philipp Brothers, Phibro. I know you were a precious metals specialist. Tell me a little bit about what it was like working there, and your thoughts now on some of the markets.
Andy Hecht: Sure. I started when I was 17 years old, while I was going to high school and college, and I delivered telexes and I worked my way up, eventually ran a couple of departments at Philipp Brothers, at Salomon Brothers, and then at Phibro Energy. Ran the precious metals department, the nickel trading, sugar trading. It was very interesting because you'd learn the physical, the derivatives, all of the markets.
As far as what's going on today, where do you want to start? I covered everything from meats to energies to precious metals.
Hard Assets Investor: Let's start with the precious metals, because I know recently, and I listened to one of your radio broadcasts, you had a bearish call on gold which turned out to be very correct. We saw the price come down back into the $1100 level. We popped back up again. What's your outlook now?
Andy Hecht: Precious metals – particularly gold – is frustrating every bull, and every bear, because it's stuck in a pretty tight range here.
The interesting thing about precious metals, Michael, is that platinum broke down. Silver broke down. The platinum/gold spread the last I looked at it is about $20, $30. Historical norms for that about a $200 premium. So that's low. That means platinum is cheap, or gold's expensive. The silver/gold ratio, the long-term norm there, is 55 to 1. That's trading around 71 to 1. So either silver is cheap, or gold is expensive. This is where the markets are now.
Hard Assets Investor: As a former physical trader, was that a very important thing for you to look at as sort of a barometer for the market overall? You looked at those spreads...?
Andy Hecht: Absolutely. And I don't only look at them in gold. I look at intercommodity spreads in everything. If you look at grains, farmers decide which grain to plant based on the ratio of corn to soybeans. It's substitution spreads. And silver versus gold, both precious metals, when silver gets too cheap, we tend to see more physical demand than silver. But we're not seeing that now.
Hard Assets Investor: This is a great tip on relative prices. There are relationships, and there are sort of boundaries. They don't really get too far out of whack most of the time.
Andy Hecht: But well, they do. And when they do get far out of whack, those are the greatest trading opportunities. Let's talk about the platinum/gold spread for a minute. You had that over the last 40 years, the lowest it's traded is a $200 discount platinum to gold. That was right after 2008 and right after the global recession. The highest that traded at was in 2007 with a $1100 premium on platinum versus gold.
The best profitable opportunities are on these extensions. And I'm seeing an extension now. So the bottom line for me is that either silver and platinum are too cheap, or gold is too expensive. And given the action in commodity markets in general, I tend to still think that gold is too expensive relative to these other precious metals.
Hard Assets Investor: Let's talk a little bit about oil markets. We've seen oil I think surprise a lot of people in the degree that it has come down. Now you have an interesting kind of thesis on what's going on here.
Andy Hecht: Well, not to try to sound too crazy, but I think that the oil price is being managed. We put together a coalition to fight ISIS in the Middle East. And we're doing that in Iraq and in Syria. And that coalition contains a lot of Arab states. And a lot of those Arab states are very big Opec producers – Saudi Arabia, Kuwait, Qatar. What I think is that the $80 price for oil is really the sweet spot for that coalition.
Let me explain why. First of all, at an $80 price, the US maintains oil independence, because you have a lot of crude, high-production-cost crude coming out of the Permian Basin, coming out of the Balkans, coming out of tar sands. And below $80, that becomes uneconomic.
We also have lower oil prices now benefit the consumer tremendously in this country. Now the interesting thing here is that one of the big things we've been trying to do is to put pressure on Mr.Putin since he took over the Crimea, since he's on the border of Ukraine. And a lower oil price is a very effective tool in fighting Mr.Putin.
Hard Assets Investor: But is $80 low enough? It's hurting their economy, we can see that.
Andy Hecht: Right. It would hurt them more at $60, but then it would start to hurt us at $60 because our oil industry would become uneconomic, and oil prices would become much more volatile and much more...If you notice, when we have these geopolitical events, oil hasn't been volatile like it was in past days. Below $70 or so I think it becomes a lot more volatile when we have an eruption in the Middle East. So it's the sweet spot.
Hard Assets Investor: Interesting thesis. Let's see, national interest correlating to a certain commodity price.
Andy Hecht: Exactly. Mark Rich, a former Phibro guy, once said, "Oil is the blood that runs through the veins of the earth." And it really affects everything. So oil is a very effective tool.
One of the things I thought that the president might do when all hell broke loose in the Middle East was to sell some SPR. I think actually if they are doing what I think they're doing, it's even more effective.
Hard Assets Investor: To just keep a lid on the price...
Andy Hecht: To manage it. And make it less volatile. Maybe it was volatile for the last month and a half or so, but maybe it won't be so volatile going forward. Time will tell.
Hard Assets Investor: When you trade nowadays – and I know you're still active as a trader – do you still prefer the futures markets, or do you do physical or ETFs?
Andy Hecht: I trade a lot of futures and options, and I love the ETF market. I think the ETF market has expanded and brought commodities trading to every portfolio and made it much easier. There are some good ETFs, and there are some bad ETFs. Like the GLD is a great ETF; it tracks gold very well.
The USO is a terrible ETF. It hasn't tracked oil well at all. But it's useful at times on a short-term basis. So I like to look at those, and I certainly kind of analyze those as well and try to pick the best vehicle. There's so many available to us now.
Hard Assets Investor: Now I know you do a little bit in the foreign currency area, and you have two favorites because they're kind of closely correlated to commodities. What are those?
Andy Hecht: Exactly. The Canadian Dollar, because the Canadian Dollar is very much an oil-based and grain-based currency. And the Aussie Dollar, because Australia is the supply zone for China. And these two currencies are really dramatically affected on a daily basis by commodity prices.
If you notice, when commodity prices started going down in early summer, those currencies kind of tanked. We went from trading the high 90's on the Aussie Dollar, the Canadian Dollar; we're down below 90 now on both. So they track very nicely. Very nice correlation. And sometimes you can set up some nice correlation spreads with specific commodities against those currencies.
Hard Assets Investor: Andy Hecht, thanks very much for coming on the show.
Andy Hecht: My pleasure. Thanks so much.
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