Gold/Silver Spread: A short Sale Signal Was Triggered

Gold/Silver Spread

Yesterday the February-March gold/silver (x7,000/oz.) spread closed below the rising 30-day Moving Average for the first time on four months. This signaled a bearish trend change and triggered a short sale signal.

The IMC blog made a hypothetical trade by selling one 100 oz. February gold contract at approximately $1,197.80 (a value of $119,780) and simultaneously buying one 5,000 oz. March silver contract and two 1,000/oz. March ‘mini’ silver futures contracts at approximately $16.61 (a total value of $116,270). This puts us in a short spread position at approximately +$3,510 (premium gold). Initially, we will liquidate the spread on a two-consecutive day close above +$7,200. This price is about $500 above the November 7th contract high of +$6,698.

February Gold March Silver (7,000 oz.) spread daily

February Gold March Silver (7,000 oz.) spread daily

Based on the price history of the gold/silver (x7,000/oz.) spread, we are expecting a decline of at least $20k from here. Hopefully, we will see some counter-trend moves along the way to give us some clues as to what we can expect for additional short sale setups and opportunities to build the position size. This could be a golden opportunity for spread traders!

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Corn/Oat Spread: Time To Roll To The March Contracts

Corn/Oat Spread

The blog entered a long position in the December corn/oat spread at ‘even money’ on October 8th and added another at +47 1/2 cents (premium corn) on November 13th.

This week the oat market plunged. The market is off nearly 22% from last month’s peak while the corn market is actually up 22% from last month’s low. This sent the December corn/oat spread to a nearly five-month high of +82 3/4 cents (premium corn) this morning.

December Corn Oat Spread Daily

December Corn Oat Spread Daily

The oat market has been the one market that did not participate in this year’s bear market in the grains. It was certainly not for lack of supply. Transportation was the problem. Oat shipments out of Canada (the world’s largest oat exporter) were delayed because record grain and oil seed crops created a shortage of rail cars and bogged the rail system. Now that the backlog has eased, oat shipments are coming in fast and furious and the corn/oat spread is returning to the mean.

March Corn Oat Spread Daily

March Corn Oat Spread Daily

First Notice Day for the December grain contracts is on Friday and the markets are closed tomorrow for Thanksgiving. Therefore, long positions need to be rolled over by today’s close to avoid possible delivery notices. The December corn/oat spread has been rising faster than the March spread and has now gained a premium over the March spread. One can now roll to the March contracts with a small premium on the December spread to pay all of the commissions. How cool is that?

When we started the trade, our minimum target was the one-dollar mark (premium corn). This could soon be achieved. We do know, however, that a large majority of the prior declines below the 50-cent level have been followed by rallies to +$1.50 or higher. Therefore, we will assess the situation after the one-dollar level has been reached. If the trend is still bullish, we will continue to stay on for the ride. Depending on the pattern that plays out, we may even look for a low-risk setup to add more to the long March corn/oat spread position in order to take full advantage of the move.

Corn Oat Spread Monthly

Corn Oat Spread Monthly

Trade Strategy:

For tracking purposes, the blog will roll the two long December corn/oat spreads (the initial position entered at ‘even money’ and the ‘add-on’ entered at +47 1/2 cents) to the March December corn/oat spreads while the December spread is trading at a premium of +2 cents or more to the March spread. Risk the March spreads to a two-day below the rising 30-day Moving Average.

Euro Bund/T-note Spread: An Exit Signal For Short Positions Was Triggered

Euro Bund/T-note Spread

On Friday, October 10th the December Euro bund/T-note spread closed below the rising weekly 15-bar Moving Average for the first time in a year and signaled a bearish trend change. This also tripped the wire for a short sale signal. The blog initiated a hypothetical short position of selling one December Euro bund short at 150.40 and simultaneously buying one December T-note at 126-17.

Euro Bund T-note Spread Weekly

Euro Bund T-note Spread Weekly

The September 30th contract high of 25.06 (premium bund) was our line in the sand for the short position. Therefore, we were risking a two-consecutive day close above 25.16.

Although the December Euro bund/T-note spread has not yet closed above 25.16 for two days in a row, there have been several one-day closings higher than 25.16. Therefore, we are going to recommend closing out the hypothetical short position right here at prices of approximately 152.31 for the December Euro bund and 127-01 for the December T-note. The trade would have resulted in a theoretical loss of approximately -$2,382 on the bund (the bund is priced in Euro currency, so the exchange rate was taken into account) and a theoretical profit of approximately +$500 on the note for a net theoretical loss of approximately -$1,882 on the entire spread.

December Euro Bund T-note Spread daily

December Euro Bund T-note Spread daily

Fundamentally, the bund continue to outperform US Treasuries as the ECB has slashed rates into negative territory and monetary policy is poised to get even more accommodative, while the debate over higher US rates revolves around the question of “when” and not “if”. This has kept the multi-year bull market in the Euro bund/T-note spread intact and penalized us for the short sale attempt. However, we do know that the bull market will end at some point. A majority of the previous trend reversals in this spread have been followed by a new trend that lasts a year or even several. Therefore, we are going to go back up to the plate and take another swing when we get the right pitch.

March Euro Bund T-note Spread Daily

March Euro Bund T-note Spread Daily

Happily, the expected divergence between European and US interest rate policies has priced the March Euro bund/T-note spread one and a half points higher than the December spread. This means that we will be looking at getting short at an even higher level than our last attempt. We will have more to say on the subject soon.

T-bond/T-notes Spread: Interval Ladder Strategy Update

The T-bond/T-note Spread Interval Ladder

On October 25th we instituted a hypothetical trade campaign for the T-bond/T-note spread. The objective was to get short and add to the position by using an interval ladder.

Due to the approaching First Notice Day for the December interest rate contracts, we are moving out to the March contracts. The March T-bond/T-note spread is trading at a discount to the December T-bond/T-note spread, so we will adjust the price intervals accordingly.

On the weekly nearest-futures chart, the rising 20-bar Moving Average provides technical support at 14-05. The spread has not closed below the weekly 20-bar MA since the first week of January, so such an event will trigger a bearish trend change signal.

March T-bond T-note spread daily

March T-bond T-note spread daily

On the daily timeframe, the March T-bond/T-note spread posted a low of 13-25.5 in late October. So far, the low for November has been 13-28.5. Since the spread has recovered two-thirds of the pullback from the contract high and we only have three trading days left for the month, odds are pretty good that the low for November is in place. Therefore, we are going to use a break below the November low and the late November low to kick off the short sale campaign.

Trade Strategy:

The blog will cancel all previous hypothetical orders to sell the December T-bond/T-note spread. Now, the blog will work hypothetical orders to sell one March T-bond/T-note spread on a close below 13-24 (premium T-bonds). If filled, the position will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the entry price. In addition, continue to short more March T-bond/T-note spreads (single contracts for sake of simplicity) on each close that is 2-08 lower than the prior entry price until a total of four units (the initial entry plus three ‘add-ons’) have been accumulated. For a trailing stop, all units will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the most recent entry price.

Feeder Cattle/Corn Spread: Entry Signal Triggered

Feeder Cattle/Corn Spread

On November 19th the blog made a hypothetical trade entry on the short side of the April feeder/May corn (x6) spread when it rallied to +$1,000 (premium feeders). The spread was initiated on a bounce to the Fibonacci .382 resistance line. Initially, we are risking a two-consecutive day close above +$6,000 (premium feeders).

We also have an additional setup to sell another 50,000 lb. April feeder cattle contract and simultaneously buy six more 5,000 bushel corn contracts if the spread closes below -$7,000 (premium corn). This ‘add-on’ position will initially be liquidated on a two-consecutive day close $500 above the highest closing price after November 18th that precedes the entry on this position.

April Feeders May Corn (x6) spread daily

April Feeders May Corn (x6) spread daily

Recall that the recent trade above ‘even money’ in the feeder/corn (x6) spread is a something that has only happened twice in history. Over four decades of history (basis the nearest-futures chart) reveals that the feeder/corn (x6) spread normally oscillates around -$60k (premium corn).   If the spread has indeed topped out and the ‘add-on’ position is triggered, we could have a tiger by the tail as the profit potential is outstanding. In the event that we are lucky enough to have entered a short sale ahead of a sizable bear market, we will certainly be looking for setups to add on as the trend unfolds. Stay tuned!

Soy Meal/Bean Oil Spread: Reversal Signal Triggered

Soy Meal/Bean Oil Spread

On November 12th the IMC blog entered a hypothetical long position in the March soy meal/bean oil spread at +$17,044 (premium meal). This initiated the start of a reversal system where closings above +$17k trigger buy signals and closings below +$15k trigger sell signals.

On November 19th the March soy meal/bean oil spread closed at +$14,354 (premium meal) and triggered a reversal signal. Therefore, the long position at +$17,044 would have been liquidated for a loss of approximately -$2,690 and a hypothetical short position would have been entered at +$14,354. A close back above +$17k will trigger the exit signal for the short position and a buy signal for a new long position.

March Soy Meal Bean Oil spread (with 20-day MA) daily

March Soy Meal Bean Oil spread (with 20-day MA) daily

Currently, the mid-November breakout above the May 30th peak and the break back below it appears to be a failed breakout attempt. If so, the spread could be at the beginning stages of a multi-month decline. We shall see…

Corn/Oat Spread: ‘Add-On’ Entry Signal Triggered

Corn/Oats Spread

On October 8th the blog entered a hypothetical long position in the December corn/oat spread at ‘even money’ when the spread closed above the declining 30-day Moving Average. Initially, we were risking a two-day close below -26 3/4 cents (premium oats). Now that the spread has been above the 30-day MA for over a month straight, we can eliminate the initial risk and even lock in a trailing profit by exiting this initial position on a two-day close below the rising 30-day MA.

December Corn Oats Spread Daily

December Corn Oats Spread Daily

Yesterday the blog entered another hypothetical long position in the December corn/oat spread at +47 1/2 cents (premium corn) when the spread closed above the August high of +43 cents. For this new ‘add-on’ position we are going to risk a two-day close below +20 cents (2 cents below the November 4th reaction low). Once the rising 30-day MA reaches +20 cents or higher, we will then risk a two-day close below the 30-day MA for both the initial position and the ‘add-on’ position.

We expect the corn/oat spread to eventually hit one-dollar (premium corn) or higher. Therefore, we will continue to watch for more low-risk setups to increase our size in the long corn/oat spread while keeping the overall trade risk steady or shrinking.

Feeder Cattle/Corn Spread: Have We Finally Reached the (Cow) Tipping Point?!

Feeder Cattle/Corn Spread

As one would intuitively think, the market prices for feeder cattle and corn show a strong correlation. Corn is the feed that is predominantly used in the livestock business and feed prices represent the lion’s share of production costs.

When you look at the last four decades of history, it is apparent that major divergences between the price of feeders and corn are temporary events. When corn soars and feeders do not participate, the corn market eventually comes crashing back to earth as feed demand dwindles. When the bottom falls out of the corn market, strong feeder prices tend to usher in a recovery in the corn prices as livestock producers are banking fat profits and buying more and more feed for herd expansion.

Feeders Corn overlay monthly

Feeders Corn overlay monthly

Things can really get crazy when a drought occurs! The drought will send corn sky-rocketing as the crop gets wiped out. The soaring corn (feed) price causes the livestock producers to suffer financial loss, so they dump their animals on the market. This increases supply and exacerbates the price decline, widening the gap between the two markets even further. Once the dust settles (pun intended), the corn and feeder markets come back into alignment. When the corn prices settle down the livestock producers will start the breeding cycle all over. It takes time to raise the new animals so tight supplies will persist for a time and send livestock prices higher. This is exactly what has been happening since the US experienced the worst drought in several decades back in the summer of 2012.

No matter what the scenario, the point is that big divergences between feeder and corn prices have historically provided great opportunities to bet on a reversion to the mean.

The Feeder/Corn Ratio

At a quick glance, it appears that the normal ratio between a 50,000 lb. feeder cattle contract and a 5,000 bushel corn contract is somewhere around 3:1. It will often oscillate between 3.5:1 and 2.5:1. It is when the ratio trades outside this band that trading opportunities materialize.

Over the last four decades, there have been about half a dozen times when the ratio fell below 2:1. At this level, the feed prices were too expensive for livestock producers. This inevitably caused a significant change in the supply/demand of one or both of the markets. The ratio then reversed and went back up above 3:1. Take note: Whenever you see the feeder/corn ratio drop below 2:1, it’s time to start looking for a setup to get long feeders and short corn.

Feeders Corn ratio monthly (continuous)

Feeders Corn ratio monthly (continuous)

On the other side of the field, the feeder/corn ratio can be considered ‘extreme’ and unsustainable when it reaches 4.8:1 (nearly five-to-one) or higher. This has only happened a handful of times in nearly half a century of trading in the futures markets. Previously, ratios at such lofty heights ultimately experienced a plunge back down to 3:1 or lower.

Common sense indicates that a reversal off the high side is inevitable. At nearly 5:1, the profit margin is so huge that producers expand the herd as fast as they possibly can. And who can blame them? You gotta get it while the gettin’ is good. However, the ramped up production leads to overproduction, which leads to a supply glut and then softer prices. Hence, the cyclical ebb and flow of the feeder/corn ratio.

Historic High = Historic Opportunity

Last month the nearest-futures feeder/corn ratio reached a mind-boggling all-time high of nearly 7.5:1. At this level, livestock producers are snatching up feed for their animals for just a song and a dance. If you see a brand new Maserati pass you by on the streets this week, don’t be surprised if the driver is in the livestock business.

Feeders Corn ratio daily (continuous)

Feeders Corn ratio daily (continuous)

In late October, the nearest-futures feeder/corn ratio closed below the rising 50-day Moving Average for the first time in nearly half a year. This signaled a bearish trend change. For more than a year, closes above/below the 50-day MA have been accurate indicators of trend changes for the feeder/corn ratio. The implication is that feeder prices are about to break, corn is going to pop, or both.

The ratio has been in an uptrend since it bottomed out during the drought of 2012 and just last month it reached uncharted territory after a 2+ year run. In light of these facts, we think it is likely that the recent trend change signal marks not just “a top” for the ratio, but “the top” for the ratio. For their sakes, let’s hope that the Maserati-driving livestock crowd has their business costs hedged.

The Feeder/Corn Spread

The ratio between one April feeder cattle futures contract and one May corn futures contract peaked at 6.75:1 at the start of October and is currently trading near 5.9:1. To normalize the relationship between these two markets, we are going to look at the spread between the value of one 50,000 lb. April feeder cattle contract and the value of the sum of six 5,000 bushel corn contracts.

April Feeders May Corn (x6) spread daily

April Feeders May Corn (x6) spread daily

At the October 3rd contract high, the April feeder/May corn (x6) spread closed at +$13,025 (premium feeders). At the nearly two-month low on Halloween, the spread was valued at -$6,400 (premium corn). As in the case of the nearest-futures feeder/corn ratio, the nearest-futures feeder/corn (x6) spread also signaled a bearish trend change last month when it closed below the rising 50-day MA for the first time since the spring. Therefore, traders should be focusing on the short side of the trade.

Feeders Corn (x6) spread monthly (continuous)

Feeders Corn (x6) spread monthly (continuous)

The September/October push above ‘even money’ in the feeder/corn (x6) spread is a rare occurrence. This was only the second time in history that a feeder contract has been worth more than six corn contracts. Looking at more than four decades of history on the nearest-futures chart, we find that the spread between the value of one feeder contract and six corn contracts usually flip-flops somewhere around -$60k (premium corn). This is exciting news as is indicates that the spread is obscenely overvalued. Opportunity abounds!

Technical Resistance Levels

Based on history, a minimum downside objective for the feeder/corn (x6) spread should be -$60k (premium corn). Therefore, a trader’s objective is to find a spot somewhere long before then to get short. If you’re lucky, the spread will get a bounce to sell into. There are currently three critical resistance levels that traders should monitor.

An ideal minimum bounce would be to the Fibonacci .382 retracement of the current decline. This resistance level currently shows up at +$1,020 (premium feeders) for the April feeder/May corn (x6) spread. This is quickly followed by the declining 30-day Moving Average around +$1,368.75 (premium feeders). The 30-day MA provided support on the way up and offered an ideal buying level in August. Now that it has been broken, the 30-day MA should provide resistance.

Next, the Fibonacci .618 retracement of the current decline sets resistance at +$5,605 (premium feeders). In a volatile market, deep retracements to the Fibonacci .618 line can provide a fantastic location to enter on a reversal.

Finally, the October 3rd contract high of +$13,025 (premium feeders) is a make-or-break level. If the spread gets back up to the old high, traders should be looking for clues of a double top, a failed breakout, or a sustained breakout. The first two scenarios create a potential setup for a short sale, while the sustained breakout would indicate that you do not want to be caught holding the bag on the short side.

Trade Strategy:

For tracking purposes, the blog will make two hypothetical trades in the April feeder/May corn (x6) spread. One trade is to get short on a bounce to the first Fibonacci resistance level and risk above the second Fibonacci resistance level. The other trade is to get short when the spread makes a new corrective low.

First, we will sell one 50,000 lb. April feeder cattle contract and simultaneously buy six 5,000 bushel corn contracts if the spread rallies to +$1,000 (premium feeders). Initially, this position will be liquidated on a two-consecutive day close above +$6,000 (premium feeders).

Second, we will sell one 50,000 lb. April feeder cattle contract and simultaneously buy six 5,000 bushel corn contracts if the spread closes below -$7,000 (premium corn). Initially, this position will be liquidated on a two-consecutive day close $500 above the highest closing price after October 31st that precedes the entry on this position.

Soy Meal/Bean Oil Spread: Entry Signal Triggered

Soy Meal/Bean Oil Spread

On November 12th the March soy meal/bean oil spread closed at +$17,044 (premium meal). This elected the blog’s hypothetical entry signal trade to buy one 100-ton soy meal March soy meal contract and simultaneously sell one 60,000 lb. March bean oil contract to establish a long spread position at approximately +$17,044 (premium meal). Initially, the exit strategy is to liquidate the spread on a close below +$15k. In addition, a close below +$15k will also trigger a sell signal to initiate a short March soy meal/bean oil spread position. This is because we are using a reversal system to maintain a continuous spread position on either the long side or the short side. Closings above +$17k trigger buy signals and closings below +$15k trigger sell signals.

March Soy Meal Bean Oil spread daily

March Soy Meal Bean Oil spread daily

The close above +$17k opens the door for the March soy meal/bean oil spread to advance toward the weekly nearest-futures chart at the summer high of +$24,726 or even the late May top at +$26,920, which marks the all-time high for the soy meal/bean oil spread.

One of these days, the two-year bull market in this spread will end. In the prior four decades, spreads of +$12k or higher have ultimately been followed by a reversal and a decline back down to ‘even money’ where the meal contract and the oil contract were of equal value. We intend to be there when it happens. But if the bulls want to run this spread up several more thousand dollars first, who are we to argue? Might as well go along for the ride and try to make a few dollars on the upside.

Soy Meal/Bean Oil Spread: Almost Time To Get Crushed?

Soy Meal/Bean Oil Spread

When you ‘crush’ a soybean, you get two things: soy meal and bean oil. Since they originate from the same source, it comes as no surprise that these two derivatives of the soybean are highly-correlated in price movement. Looking at a comparison of these two markets over the last forty-plus years will reveal that the correlation is quite strong: When one market goes up, the other usually follows. When market goes down, the other usually drops in sympathy.

Soy Meal Bean Oil overlay monthly

Soy Meal Bean Oil overlay monthly

However, one can also see periods where one of the soy products would make a major move and the other market did not respond. Or at least, it was a delayed reaction. This is because the slightly different usage (soy meal is widely used as livestock feed while bean oil has industrial and food usage) means that the supply and demand factors in these two markets are not always aligned. Ultimately, however, these two soy products have always gotten back in sync.

Spread Extremes

Since 1968 there have only been about half a dozen times when the value of one soy meal contract reached a premium of +$12k or more over the value of one bean oil contract. Usually, the spread would peak and go all the way back down to ‘even money’ where the values of the meal contract and the oil contract were equal.

Soy Meal Bean Oil spread monthly

Soy Meal Bean Oil spread monthly

For the last two years, however, the spread has stayed elevated at historical highs. This is likely due to the fact that livestock prices are at record levels, creating strong demand for feed (soy meal).

Regardless of the high price of the spread, we do not want to become complacent and believe that this is the ‘new normal’. This recent push to record highs with the longest duration of staying at an extreme could be setting the soy meal/bean oil spread up for a major bear market. A short sale opportunity may be right around the corner.

Ratio Extremes

Soy Meal Bean Oil ratio monthly

Soy Meal Bean Oil ratio monthly

The ratio between a December soy meal contract and a December bean oil contract reached a contract high of 2:1 this week, meaning that a soy meal contract is worth twice as much as a December bean oil contract. A nearest-futures monthly chart shows that the soy meal/bean oil ratio has only reached 2:1 half a dozen times in the last forty-five years. This ratio corroborates the theory that the spread is priced at an historic extreme and ripe for a major reversal.

Trend Change Signal

Since we are less than a month away from December, we are tracking the March soy meal/bean oil spread. It’s a little cheaper than the December contracts.

March Soy Meal Bean Oil spread daily

March Soy Meal Bean Oil spread daily

Over the last five weeks, the March soy meal/bean oil spread has run from the October 1st ten-month low of +$9,550 (premium meal) to the November 7th nearly five-month high of +$15,746. The spread has closed above the rising 20-day Moving Average every single day for nearly a month straight. Therefore, a close back below the 20-day MA (currently around +$13,351) could signal a bearish trend change.

Make-or-Break Levels

On the daily timeframe, the March soy meal/bean oil ratio ended the week at 1.8:1 which matches the September 2nd contract high of 1.8:1. The spread closed at +$15,746, which is a mere $892 away from the May 30th contract high of +$16,638. A reversal from this level could start a major decline, but a sustained breakout to new highs could clear the way for the March soy meal/bean oil spread to start a run toward prior peaks on the weekly nearest-futures chart at the summer high of +$24,726 or even the late May top at +$26,920 (the all-time high for the spread).

The current placement of the spread might be a good place to use a reversal system which continually maintains a position in the market. The spread position simply switches back and forth from long to short as per some set price parameters.

To determine the parameters for a reversal system, we will first look at the countertrend moves of the last few months. During the rally from the early March low to the late May top, the largest pullback that the March soy meal/bean oil spread experienced was $1,378. During the decline from the late May top to the mid-June bottom, the largest bounce was $1,260. The largest pullback during the mid-June to early September run was $1,140. The one-month decline from the September 2nd top to the October 1st low was very compressed as the largest bounce was a mere $552. Finally, the largest pullback during the current run from the October 1st low was a more normal $1,514. In light of this, we would be inclined to use a bracket of $2k between the upside buy level for the spread and the downside sell level for the spread. This will hopefully keep the spread placed beyond the noise of random and expected market swings. One could use even larger intervals to filter out false signals, but the trade-off is that the risk/reward would be diminished.

Trade Strategy:

For tracking purposes, the blog will hypothetically implement a reversal system for the soy meal/bean oil spread with a position consisting of one 100-ton soy meal March soy meal contract and one 60,000 lb. March bean oil contract. A long position (long meal and short oil) will be initiated on a close above +$17k and a short position (short meal and long oil) will be initiated on a close below +$15k. Each price level will act as a stop and reverse point. For example, if a long position is entered on a close above +$17k then a close below +$15k will trigger a signal to liquidate the long position and initiate a short position. If a short position is entered on a close below +$15k then a close above +$17k will trigger a signal to liquidate the short position and initiate a long position.