Feeder Cattle/Corn Spread
Over the last couple of months, the livestock markets have been on a rebound. At the same time, the feed grain markets have continued to slide. This has caused a recovery in the spread between feeder cattle and corn.
The August-September feeder/corn (x6) spread dropped nearly $31k in value as it declined from the October 3rd contract high into the December/February double bottom. Since then it has retraced more than two-thirds of the decline, closing at a seven-month high of -$300 (premium corn) today.
At today’s closing prices, the ratio between the value of one August feeder futures contract and one 5,000 bushel September corn futures contract neared 6:1. This is a rare event. Over the last four decades, there have only been a few times when the feeder/corn ratio made it to 4.8:1 (nearly five-to-one) or higher. Each time, it eventually reversed and plunged to 3:1 or lower. Therefore, history suggests that the current relationship is unsustainable. The feeder/corn (x6) spread is very likely to make a major reversal, followed by a significant decline.
The Current Setup
On Monday the August-September feeder/corn (x6) spread pulled back to a nearly three-week low and tagged the rising 20-day Moving Average. It then recovered and ended the week at a new multi-month high. If the recovery fails and the spread closes below the 20-day MA for the first time in a month and cracks the May 18th reaction low, it could indicate that the recovery has ended. If so, traders would have a good reason to start attacking the spread from the short side again.
For tracking purposes, the blog will make a hypothetical trade by selling one 50,000 lb. August feeder cattle contract and simultaneously buying six 5,000 bushel September corn contracts if the spread closes below -$4,250 (premium corn). Initially, the spread will be liquidated on a two-consecutive day close $500 above the multi-month rally high that precedes the entry (currently at -$300).