SP500 vs Gold, using their correlation to make a trading strategy (Part 1)

This post is part of a new series in which I will show how to figure out if we can build a strategy using some assets’ correlation. Let me introduce the assets:

S&P500

    Mini S&P500 future (continuous contract), daily, Source: TradingView

The Standard & Poor's 500 is one of the main American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. As you can see, this index hasn´t stopped raising since 2011. 

Gold

    Comex Gold future (continuous contract), daily, Source: TradingView

The Comex Gold is one of the most important futures. You can trade it directly or you can use it to hedge your stock portfolio. Historically this hedge has been successful and has protected the portfolios versus big drawdowns. It´s recommended to have at least a small part of your investments in gold (even if it´s in an exchange-traded fund that tracks this metal)

I reviewed Gold futures and ETF´s last year: Gold Analysis

 

Spread between SP500 and Gold

    Spread between SP500 and Gold futures, daily, Source: TradingView

To simplify the calculation, I decided to make the spread as 1 E-mini S&P500 future minus 1 Comex Gold future. As you can see, the relationship was negative before 2013 because the gold price was higher than the S&P. Since then, this spread has raised almost like the US index. This explains that the different QE programs calmed down the uncertainty (so the investors started buying the S&P and started selling or reducing their gold portfolio)

Introduction to the study

Correlation series

For this part, I chose 4 correlation series (20, 60, 120 and 250 days) that represent different time frames. 

      Correlation time frames table, own elaboration

The main reason for choosing this time frames is to make comparisons and to see if I can work out a strategy in the following posts. 

     S&P500 and Gold correlation series, own elaboration

We can’t get any conclusion from this chart apart that the long-term correlation between S&P500 and gold is negative (the most part of the time).  One of the things I would like to study in the following days is if I can build a profitable system based on the correlation series divergences. For now, I can show the different charts with the asset prices and the correlation (The Y left axis represents the price of the assets and the Y right axis represents the correlation coefficient):

     S&P500, Gold, and  20 days correlation serie, own elaboration

This chart doesn’t show any clear relationship. Another problem is that is a short-term correlation that generates a lot of noise in the signals and it´s difficult to know if it´s worth to check this correlation to trade the spread.

    S&P500, Gold, and  60 days correlation serie, own elaboration

The 60-day correlation is smoother than the previous one. I think that we can take advantage of the correlation every time that is above 0, however, a statistical study is required. 

  S&P500, Gold, and  120 and 250 days correlation series, own elaboration

As I said before, we can see that the most part of the time these correlations are below 0. Like in the previous chart we can take advantage of the correlation above 0. In addition, I would be interesting to study a trading system based on the 120 days correlations that trigger a trade every time is under -0.2. In terms of correlation’s divergence, we need to backtest it properly.

Sum up

I’ve chosen these assets because they are really important. The S&P500 reflects the US economy and the Comex Gold can be used as an investment or as a hedge vs the main index in a recession. Sadly this post is an introduction. I will analyze the systems proposed using advanced statistics and some backtests. As a reminder, the systems will be based on the correlation and its divergences. 

#trading #investing #correlation #ES #GC #SP500 #Gold #statistics

How to trade seasonality in commodities

Introduction

There are different types of commodities, I like to classify them into three groups: energies, metals, and agriculturals. Each group has different characteristics, but high volatility is the common characteristic of all the groups. It is higher than in another kind of assets, the reasons are the following:

• There is less liquidity than other assets
• The supply of these commodities depends on the weather and another less probable natural disasters such as earthquakes, hurricanes, floods, and droughts
• The Supply and demand relationship is more important than in other assets
• There is geopolitical risk
• Some commodities are correlated with the economy (in a positive way or negative if they are considered as a safe haven)

Would you buy a winter coat in August? I’ll be able to do it without any problem because it´s cheaper than in autumn and winter. The demand for this product is lower in summer, the fashion world moves quick and maybe the style of the coat won´t be as trendy as the last season. As soon as the winter comes the demand increases and I can re-sell it and get more money than I paid. This is a humoristic explanation and I hope that you got the point. You can use the same rational process to analyze commodities. Let’s check some examples:

Energy Commodities

Heating Oil Futures

    Source: TradingView, Heating Oil Futures

I have highlighted some seasonal trends I saw during the last 3 years. You can see that May and August are the most important. In 2015, this market was bearish this is why the first trade didn’t work. The August trade was successful in the period shown.

According to other websites, the ideal trade would be: buying in July and selling in December. I’d like to recommend Moore Research Center Inc because they have done research since a long time ago and they offer very interesting services. I don’t have any business relationship with them.

Heating Oil Nov17 vs Aug18

    Source: TradingView, Heating Oil Nov17 vs Heating Oil Aug18, Daily

The November contract is represented by the blue area while the August contract is represented by the orange line. As you can see in the warmer period, Spring and Summer, the winter contract trades below the summer contract. But this relationship reverses as soon as the weather becomes colder.

    Source: TradingView, Heating Oil spread Nov17-Aug18, Daily

This is one of the best examples of how the spreads trend better than the outrights. It´s been going up since July.

Agriculturals

Soybean Oil Futures

     Source: TradingView, Soybean Oil Futures, daily

The soybean oil usually trends up between February and April, and between October and November. The successful trades would have been 66% or 4 out of 6 times. This is why we always should question the online and published research before trading. Every day in the markets is different.

Precious Metals

The seasonality in precious metals is driven by the demand. The Gold and Silver prices usually rise between November and February due to the Christmas, New Year’s holiday season and the Wedding season in India. Another period of rises is between August and September. It´s difficult to see in a candle chart but if you calculate the monthly change and compare with the previous years.

Gold Futures

    Source: TradingView, Gold Futures, daily

As you can see the strongest seasonality is in the first two months of each year.  The Aug-Sep seasonality is not as strong as the beginning of the year. As you can see it didn´t work in 2014. Gold is considered a safe haven, so its value will rise if the risk is increasing because the most part of the people will buy gold to hedge their portfolios.

                                       Source: commodityseasonality.com, 20 Year average performance for Gold

This chart confirms what I said before and I believe that is one of the best ways to check seasonality. That’s a great job by the commodityseasonality.com authors.

                                       Source: commodityseasonality.com, 20 Year average performance for Silver

This is another example to show that Silver seasonality has the same pattern as Gold.

How should we trade it?

After this brief explanation, we understand how the seasonality works and why the prices go up during some months. There are a lot of possibilities but I’m going to propose two of them:

Trade the outright of the one of the strongest month. This involves a lot of risks, you need to deposit a high margin and the size of your portfolio should be big, the transaction cost is lower than a calendar spread or another kind of spread.

Trade the spread between a high demand month and a low demand month, for example, February vs April. It´s less risky, the trading fees are higher, the margin you need to deposit is lower than if you trade the outrights. Is it worth?

Gold Spread February18-April18

     Source: TradingView, Gold Spread Feb18-Apr18, Daily

This is a trader’s dream. It doesn’t matter the seasonality in this spread, the most important thing is choosing the levels and applying good risk management.

Conclusion

The commodities world is very interesting and offers a lot of opportunities to trade. You can apply different strategies, this post is based on seasonality. One of the disadvantages is the high volatility. As I explained before, you can use spreads in order to reduce volatility and limit the risk involved.  You shouldn’t base your decisions on only one factor, remember that can be affected by different factors: weather, supply and demand, geopolitical situation, economic growth. I hope it helps.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverages involved

Gold analysis

Today I’m going to analyze the gold futures. Apart from investment purposes, the Gold is used to hedge a portfolio versus unexpected situations. This is based on the negative correlation between this commodity and the stock market, as I will show later. It’s recommended to have at least a small percentage of your portfolio invested in gold. Ray Dalio advised to buy gold and increase the weight of this commodity in your portfolio to 5-10%. Another Hedge Fund managers, such as George Soros and John Paulson, invest in gold through Exchange Traded Funds. Let me recap the ways to invest in this commodity:

1. Gold Bullion, buy physical gold
2. Gold ETFs (Exchange traded funds), the most traded ones are SPDR Gold Shares, iShares Comex Gold Trust and ETFS Gold Trust
3. Gold ETNs, exchange-traded notes, debt instruments that track an index. It´s like to make a deposit in a savings account in which the return is based on the performance of the underlying product is based on. This is like buying the Comex future contract, it’s riskier than the first two options, there is no principal protection and you can lose all of your money.
4. Gold miner stocks, this strategy is risky because you should consider the price of the gold and study the company in order to know if it’s worth to invest or not.

    Source: TradingView, Comparison between Comex Gold Futures and S&P 500 Index

Please bear in mind that with the quantitative easing programs, the correlation between gold and the stock market is not like in the past.

Comex Gold Futures

    Source: TradingView, Comex Gold Futures, Daily

As you can see the gold contracts have been raising since the beginning of the year. The max of the year was driven by the growing tensions with North Korea. It has retraced since the maximums of the year in September. The area between 1300 and 1200 is the most important and I think that it will be trading between this levels in the short term. I think we will see significant moves as soon as the central banks start to reduce the stimulus. These are the levels I consider important:

Resistance 2	1338.0
Resistance 1	1298.1
Support 1	1261.1
Support 2	1217.2

Gold offers protection, insurance against inflation, currency debasement, and global uncertainty. In my opinion, everyone should invest part of the portfolio in gold.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverages involved