Follow Up On Platinum As A Proxy For The Euro

Includes: FXE, PPLT, SDS
by: Roger Nusbaum

A few weeks ago I posted a recap from the Delivering Alpha Conference, as posted elsewhere, and talked about a couple of the ideas in a little more detail. One of the ideas not discussed for lack of detail provided elsewhere was shorting platinum as a proxy for shorting the euro.

This idea resurfaced Thursday in this article at the Wall Street Journal. The trade comes from Kathleen Kelly of Queen Anne's Gate Capital Management. The concept is easy to understand. Platinum is used to manage emissions from diesel vehicles and Europe has a lot of diesel vehicles. The rough economic times in Europe means fewer new cars are being purchased, which means less demand for platinum, so platinum drops in price.

The WSJ article notes that this has worked because platinum has indeed gone down in price. From the article though it is not clear whether the trade has been correct for the right reason or for the wrong reason. For example, if 2% of platinum consumption is used in new cars sold in Europe, then it becomes more difficult to connect the dots than if 15% of platinum consumption is used here and the article doesn't say.

Supporting the idea that this has actually been a well thought out and well executed trade is the history of the correlation between the euro, as measured by FXE, and platinum, as measured by PPLT. Since the launch of PPLT, at times the correlation has been negative and at other times the correlation has been pretty tight, as has been the case for much of 2012.

In picking platinum as a proxy for the euro, Kelly had to first draw a bearish conclusion on the euro and then correctly determine that the correlation between platinum and the euro would tighten. It appears to me that the reason to use platinum as a proxy for the euro in this case, was to get a sort of leverage in the trade.

Both the euro and platinum peaked in late February. Since that peak, FXE is down 7.2% and PPLT is down 18.3%, so there was more bang for the buck using platinum. There is no mention as to whether Kelly used actual leverage in putting on the short platinum position. However, the more bang for the buck concept is something we've discussed here in the context of using SDS as a hedge, while at other times increasing the beta of the portfolio as a means of increasing equity market exposure.

This specific type of trade is probably not one I would do because of the extra layer of the manner in which the correlation between the two can change meaningfully. This trade is like a two level proxy, which becomes more difficult to explains to clients versus a one level proxy.

Zooming out a little we consider many of our holdings to be proxies for various effects we try to include in the portfolio. Such as Statoil (NYSE:STO), which is by far the largest company in Norway and is a proxy for Norway in our opinion. It has been in client portfolios for many years, subject to the occasional rebalancing trade.