Platinum/Gold Spread: Trade and Strategy Update

Platinum/Gold Spread

Turmoil in Greece, the slowest economic growth in decades in China (not to mention the recent stock market crash), and the coming (expected) start of interest hikes in the US have been smashing the precious metals and industrial metals for months on end.

Eroding economic conditions means that car sales will slow down. Since platinum is used in the automotive industry for catalytic convertors, it has dropped even faster than gold. Furthermore, platinum supplies from South Africa have increased markedly since last year. This is all fodder for a continued bear market.

Platinum Gold overlay weekly

Platinum Gold overlay weekly

Currently, platinum has been priced at a discount to gold for a little over six consecutive months. This is the sixth-longest duration that the spread has been below ‘even money’ in the last forty-five years. It is impressive, but the prior inversion periods show that this can stretch out a lot longer.

Prior inversions have lasted nearly seven months (late December 1974 through mid-July 1975), seven and a half months (early December 1980 through late July 1981), ten months (the second half of March 2012 through mid-January 2013), 1-year and 2-months (late June 1984 through late August 1985) and 1-year and 7-months (mid-September 1981 through April 1983).

On July 9th the January 2016-Dcember 2015 platinum/gold spread set a new contract low of -$137.40. On the weekly nearest-futures chart, the low of this decline so far has been -$130.90 (premium gold). Only the 2012 weekly lows posted substantially lower prices of -$212.30 in January 2012 and -$219.80 in August 2012.

The point of all this is that the current size and duration of the decline below ‘even money’ is significant. Although history shows that it has lasted longer and gone lower, we do know that this inversion between platinum and gold prices has always turned out to be a buying opportunity for informed spread traders. There is no reason that this should be any different.

What Will It Take?

To indicate that this near market is over, we would like to see the platinum/gold spread make a two-day close above the declining 75-day Moving Average for the first time in nearly a year. A breakout above a previous month’s high for the first time since March and only the second time during this thirteen-month bear market would alter the bearish price structure and confirm the turnaround. Once this occurs, the bear market should be over and the spread should rocket back above the ‘even money’ mark.

Platinum Gold spread nearest-futures daily (75-day MA)

Platinum Gold spread nearest-futures daily (75-day MA)

Conversely, a close below the July 9th contract low of -$137.40 (premium gold) would keep the platinum/gold spread on course for a return to a double bottom at the nearest-futures record lows at the December 7, 2011 low of -$218.90 and the August 10, 2012 low of -$219.80.

Fully Committed

Normally, we stalk a qualified spread with technical parameters to get positioned on a reversal. Once we’re in, another reversal to new lows in a downtrend or new highs in an uptrend will be our cue to exit stage right with a temporary loss and wait for a new entry signal. It’s nice, neat, simple and logical.

But once in a great while, we see a spread that reaches its lowest or second-lowest level in history. If the spread is between highly-correlated markets with a strong fundamental link, the ratio corroborates the historically extreme reading, and the carry-charge several months out is not unreasonable, then a spread trade position can be treated more like an investment.

To ‘invest’ in a spread, one needs to greatly reduce or even eliminate the leverage. This gives you staying power in the event that the spread continues to move adversely. That way, there is no risk of a deficit or even a margin call on the position.

Our viewpoint is that one side of the spread should be backed with the full value of the contract. Since the other side of the spread is positioned in the opposite direction with a highly correlated market, it acts as a hedge to this unleveraged position.

For example, the January 2016-Dcember 2015 platinum/gold spread closed at an historically low price of -$103.70. If we were to ‘invest’ in this spread we would buy two 50/oz. January platinum contracts at the closing price of $982.30. To do this unleveraged, we would back this position up with $98,230. At the same time, we would short a 100 oz. December 2015 gold contract at $1,086.00 (value of $108,600). This should act as a hedge to the long platinum position. Now we just sit back and wait for the trend reversal. If it doesn’t happen by the first notice day for the December gold contract, we simply roll to the further out spreads.

Stepping On the Accelerator

Somewhere down the road, there will be a time to increase the leverage on the investment position. After all, you should want to maximize the profit opportunity of holding a spread that’s entered in the right direction at a price that’s rarely seen. That will happen if/when the position is showing a healthy open profit that can cushion a drawdown on an additional spread.

Note, however, that this additional spread will require an exit parameter in the event that it moves too far against you. This is because it is a leveraged position.

The strategy requires some patience, but the payoff can be well worth it. There are hedge funds, CTAs, famous traders, etc. that have built their fortunes and substantially outperformed the market benchmarks using this sort of strategy. So it certainly makes sense that an individual trader/investor should explore this method.

Trade Strategy:

Cancel the current hypothetical order in the October platinum/gold spread. The IMC blog will now work the following trade entry contingencies. Take whichever one is elected first as the signal to get long:

  1. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread makes a two-day close above the declining 75-day MA (currently around -$79.40). If filled, the initial liquidation plan is to exit on a two-consecutive day close $5/oz. below the contract low that precedes the entry (currently at -$137.40).
  2. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread closes above the July 2nd bounce high of -$80.40. If filled, the initial liquidation plan is to exit on a two-consecutive day close $5/oz. below the contract low that precedes the entry (currently at -$137.40).

Investment Strategy:

In addition, we will now work the following three ‘investment’ entry contingencies. Take whichever one is elected first:

  1. Sell one 100 oz. December 2015 gold contract at $1,000.00 on a GTC stop order. If filled, immediately buy two 50/oz. January platinum contracts at-the-market. Initially, there will be no liquidation parameters for this low-leverage position.
  2. Buy two 50/oz. January platinum contracts at $775.00 on a GTC limit order. If filled, immediately sell one 100 oz. December 2015 gold contract at-the-market. Initially, there will be no liquidation parameters for this low-leverage position.
  3. Buy two 50/oz. January platinum contracts and simultaneously sell one 100 oz. December 2015 gold contract if the spread trades to -$200.00. Initially, there will be no liquidation parameters for this low-leverage position.

 

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Cocoa/Sugar Spread: Raise the Short Sale Entry Price Again

Cocoa/Sugar Spread

For the seventh time in the last eight months, the nearest-futures cocoa/sugar (x2) spread made a higher monthly high. The July 20th high of +$7,904.40 (premium cocoa) is the biggest premium that one cocoa contract in twenty-nine years. However, this is only just a little bit beyond weekly double top between the 2008 high of +$7,258.80 and the 2002 high of +$7,771.60. A reversal from here on the weekly charts would create a failed breakout attempt or a sloppy-looking triple top.

Based on historical precedent, we expect a reversal in the cocoa/sugar (x2) spread to be followed by a minimum bear market decline of $23k per spread. Remember, this is the minimum expectation. The spread has made much larger declines than this from historic extremes.

With only three trading days left for July, we are going to raise the entry signal parameters again. What we are looking for is a change in the current bullish price structure to tell us that conditions are changing and that the spread is ready to reverse. A break below price support would accomplish this.

What to Watch For

Since bottoming in the second half of January, the December-October cocoa/sugar (x2) spread has not traded below a prior month’s low. This makes the July low (currently at +$4,754.80) a key point to watch. Furthermore, the spread has closed above the rising 50-day Moving Average every single day since early February.

December Cocoa October Sugar (x2) spread daily

December Cocoa October Sugar (x2) spread daily

Coincidentally, the July low and the 50-day MA are in close proximity to each other right now. A two-day close below the 50-day MA for the first time in nearly half a year and a break below a prior month’s low would alter the price structure and entice us into the short side of a December-October cocoa/sugar (x2) spread. Once a bear market starts to materialize with defining resistance levels, we will talk about adding to the position.

Trade Strategy:

Cancel the current hypothetical order in the September-October cocoa/sugar (x2) spread. Place a new hypothetical order to sell one 10-ton December cocoa contract (note that we changed from the September contract) and simultaneously buy two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 50-day MA (currently around +$4,841) or a one-day close below the current July low at +$4,754.80, whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.

 

 

Grain Basket Spread: Let’s Set a Profit Target

The Grain Basket Spread

On July 14th a hypothetical long position was initiated in the Nov-Dec 2016 Grain Basket spread (long one November 2016 soybean, short one December 2016 wheat, and short one December 2016 corn) at approximately -61 1/2 cents (premium the sum of the wheat and corn).

We bought this distant month spread because of its unusually steep discount to the nearest-futures spread and also because it was approaching a level that is historically cheap.

At the beginning of the month, the beans were priced at a discount of one dollar to the sum of the wheat and the corn. On the nearest-futures monthly chart, whenever this Grain Basket spread dropped to a discount of one dollar or more and reversed, it ultimately inverted and went back up to a premium of +$1.50 (premium beans) or more.

Like a Broken Record

The problem is, the nearest-futures Grain Basket spread has not been inverted for over two years. It appears to be a distant-month contract anomaly. Therefore, we are going to shorten our timeframe a bit and put a profit target on the current position.

Over the last year, it appears that the Nov-Dec 2016 Grain Basket spread has had a hard time keeping its head above the ‘even money’ mark:

-After reaching a premium of +12 cents last July, the spread rolled over and dropped nearly 56 cents in a month.

-By late September the spread was a half-cent away from the July top. It didn’t last long. The spread dropped 61-cents over the next four weeks.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

-On November 11th the Nov-Dec 2016 Grain Basket spread spiked to a new multi-month high of +14 1/4 cents (premium beans). Was this finally a bullish breakout?! Nope. Three weeks later, it had dropped to a new multi-month low as it lost 87-cents.

-The next time the spread cleared the ‘even money’ mark was in late February. It lasted two days. One month later, the spread had declined 70 cents from the peak.

-On April 27th we saw a one-day close above ‘even money’ and then a pullback for the rest of the week. On Cinco de Mayo, there was one more close above ‘even money’ when November 2016 soybeans gained a two-cent premium over the sum of the December 2016 wheat and December 2016 corn. From this top, it began a nearly two-month decline and posted a new contract low of -$1.02 3/4 on the last day of June.

If You Can’t Beat ‘Em…

Based on the behavior pattern of the last year, it seems that the logical thing to do is exit a long position if the Nov-Dec 2016 Grain Basket spread closes at ‘even money’ or higher. We can then look for a reentry if it drops back to a discount of half a dollar or more. If Murphy’s Law comes into play and the spread finally makes a breakout and never looks back…well, at least we got a little piece of the action and bagged another profit. We’ll simply take the winnings and go shopping for some new bargains elsewhere.

Trade Strategy:

On the long position in the Nov-Dec 2016 Grain Basket spread entered at approximately -61 1/2 cents (premium the sum of the wheat and corn), exit on a close at ‘even money’ or higher.

Hog/Corn Spread: We Booked Another Profit Trading Ham and Corn Flakes!

Lean Hog/Corn Spread

The IMC blog initiated a hypothetical short position in the August-September hog/corn spread at +$14,312.50 (premium hogs) on June 3rd. After the break below the March 23rd low of +$9,635, we adjusted our exit criteria to liquidate the spread on a two-consecutive day close back above this price.

The exit signal was triggered at today’s close of +$10,025. This knocked the position out with a respectable profit of +$4,287.50, not including commissions.

August Lean Hog September Corn spread daily

August Lean Hog September Corn spread daily

Now that we’re on the side lines, we will be monitoring the hog/corn spread for the December contracts and further out. We’ll sit up and pay close attention if we see a rally to +$15k or higher, or if we see a drop to ‘even money’ or lower. Let the novice trade the ‘no man’s land’ in between. We are only interested when there’s a high-probability situation.

Feeder/Corn Spread: The Exit Signal Was Triggered and Profits Were Taken

Feeder Cattle/Corn Spread

A hypothetical short position was initiated in the August-September feeder/corn (x6) spread at -$6,975 (premium the sum of the six corn contracts) on June 25th.

After cracking price support between the December and February lows, we decided to use a two-day close back above this area as a new exit signal. This is because a break below support, followed by a quick recovery back above it, would signal a failed bearish breakout attempt. Usually, a sustained rally would follow such an event. We call this a Wash & Rinse buy signal. At the very least, it is a good reason to exit short positions.

October Feeders September Corn (x6) spread daily

October Feeders September Corn (x6) spread daily

The liquidation parameters were triggered at yesterday’s close of -$14,975. This was the second day in a row that the August-September feeder/corn (x6) spread closed above -$22,500. The hypothetical short position would have been exited with s profit of approximately $8,000, not including commissions. We will now sit on the sidelines and see how far it runs. With a little luck, we might see a run to the Fibonacci .618 retracement before we get a reentry setup. This would put the spread in close proximity to the original entry price.

Soy Meal/Bean Oil Spread: The Reversal System Buy Signal Was Triggered

Soy Meal/Bean Oil Spread

On June 30th the IMC blog entered a hypothetical short position in the December soy meal/bean oil spread at approximately +$13,664 (premium meal). This was the initiating of a reversal system that keeps us in the spread at all times either long or short. The goal is to always be short on a close below +$13,500 and always be long on a close above +$15,500.

December Soy Meal Bean Oil spread daily

December Soy Meal Bean Oil spread daily

Yesterday the spread closed at +$15,818 and set off the buy signal. The short position was exited with a loss of approximately -$2,154 and a long position was initiated at +$15,818. In keeping with the reversal system, a close below $13,500 will be the trigger to exit this long position and simultaneously go short again.

As long as the December soy meal/bean oil spread stays above the prior contract high from last November, there is no price resistance until it reaches the monthly nearest-futures double top at the 1973 historic high of +$26,580 and the 2014 record high of +$26,920. That’s another +$11k from here.

Soy Meal Bean Oil spread monthly

Soy Meal Bean Oil spread monthly

Conversely, a close back under the November 13th high of +$14,854 and the December 22nd high of +$14,582 would trigger a Wash & Rinse sell signal and indicate that the breakout was a failure. A close below +$13,500 would put us back into a short position and hopefully start the overdue return to the ‘even money’ level.

Grain Basket Spread: The Entry Signal For the Late 2016 Spread Was Triggered

The Grain Basket Spread

Today the IMC blog entered a long position in what we call the Grain Basket spread. This is the difference between soybeans and the sum of wheat and corn.

The position would have been initiated by purchasing one 5,000 bushel November 2016 soybean contract at $9.70 3/4, shorting one 5,000 bushel December 2016 wheat contract at $5.95 1/2, and shorting one 5,000 bushel December 2016 corn contract at $4.36 3/4. Since the sum of the wheat and the corn is $10.32 1/4, the spread was purchased at a price of -61 1/2 cents (premium the sum of the wheat and corn).

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

Initially, the exit criteria it to bail out on a two-day close below -$1.07 3/4. This is a nickel below the June 30th contract low. If the Nov-Dec 2016 Grain Basket spread gets back up near the ‘even money’ level where the price of beans is equal to the sum of the wheat and corn we should have room to raise the exit level and lock in a profit.

Feeder/Corn Spread: Lower the Exit Level and Lock In Some Profits

Feeder Cattle/Corn Spread

The blog entered a short position in the August-September feeder/corn (x6) spread at -$6,975 (premium the sum of the six corn contracts) on June 25th. The spread continued to freefall and it posted a new contract low yesterday.

The December and February lows of -$22,625 and -$23,350 were broken last week, sealing the spread’s fate. Now that it has been broken, these prior lows have gone from being a price support level to being a price resistance level.

October Feeders September Corn (x6) spread daily

October Feeders September Corn (x6) spread daily

In the event that the August-September feeder/corn (x6) spread does close back above these old lows, we will have a Wash & Rinse buy signal on our hands. If that happens, it may be time to bag the profits and wait for a new setup. Therefore, we are going to recommend using the Wash & Rinse buy signal as our new liquidation criteria.

Trade Strategy:

On the short position in the August-September feeder/corn (x6) spread, change the exit signal from a close above +$4,300 to a two-day close above -$22,500.

S&P 500: The Gap & Fill Buy Signal Triggered!

The S&P 500

Two weeks ago, we noted the ‘gap down’ open in the S&P 500 on both the daily and weekly timeframes. We laid out our case for why a rally back up to the prior week’s low would be a good buy signal.

E-mini S&P 500 Daily

E-mini S&P 500 Daily

The buy signal was triggered today when the September E-mini S&P 500 contract rallied to 2087.25. The initial protective sell stop for the position was to be placed two full points below the correction low. Since the July 6th low was 2034.25, the sell stop should be working at 2032.25. This 55-point risk is worth $2,750 on an E-mini contract and $13,750 on the big contract. The reality, though, is that a trader is likely doing five E-mini contracts instead of one full-size contract. The open interest in the E-minis is currently at 2,697,192 contracts, while the open interest in the full-size is only at 108,646 contracts. Even if we account for the fact that each full-size contract is five times the size of an E-mini contract, the open interest in the E-mini contract is still five times greater than the full-size contract. When you are trading, liquidity is an important consideration.

Pattern Déjà vu

This is interesting: A ‘gap’ open in the S&P 500 is not a very common occurrence, especially since the market now trades around the clock. Furthermore, a ‘gap’ open on the weekly timeframe is even more unusual. So it’s a curious thing that last week the September S&P 500 futures market opened ‘gap down’ on both the daily and weekly timeframes for the second week in a row!

E-mini S&P 500 Weekly

E-mini S&P 500 Weekly

Last week’s gap was filled before the day was out, triggering a Gap & Fill buy signal when the September S&P 500 rallied to the June 30th low of 2046.75. Monday’s low of 2034.25 low was the low that preceded the filled gap, so a trader using a protective sell stop two points below would only have a 14.5-point risk on the trade. Nothing spectacular if you’re day trading it, but it sets up a phenomenal reward-to-risk scenario if it’s a position trade. As you can tell by all of the blog posts, we prefer to hold on for the larger trends. As that old trader’s axiom goes, “The big money is made in the big moves”.

Cash Market Reinforcement

One thing we neglected to mention earlier is the importance of the cash market. In particular, the relationship between the cash S&P 500 and the monthly 10-bar Moving Average. Since one month contains about twenty trading days, a 10-bar Moving Average on the monthly timeframe corresponds with the 200-bar Moving Average on the daily timeframe.

Over the last several decades, end-of-month closes above/below the monthly 10-bar MA have signaled many accurate trend changes in the cash S&P 500. When the signal is correct, it often stays in place for years at a time. When the signal is wrong it is usually reversed within a couple of months. The cash S&P 500 has now closed above the monthly 10-bar MA every single month for three and a half years straight. This indicates that the macro trend is still bullish.

Once a trend is established via the monthly 10-bar MA, trades on the other side of the monthly 10-bar MA are viewed as corrective moves and expected to be temporary events. They are considered entry setups in the direction of the macro trend. Therefore, a trade below the monthly 10-bar MA followed by a rebound back above it would provide traders with a setup to get long and risk to a new correction low. The position would be trailed with exit criteria to liquidate on an end-of-month close below the monthly 10-bar MA.

S&P 500 (cash) Monthly

S&P 500 (cash) Monthly

For the record, previous setups like this over the last three years have been followed by rallies to new all-time highs. Traders who took advantage of this setup would have bought when the cash S&P 500 was around 1300 in early June of 2012, during the mid-October correction when the cash S&P 500 was around 1906, and again this year on Groundhog’s Day when the cash S&P 500 was around 1995. No exit signals have been triggered yet, so traders would have pyramided this into a profitable long position.

The recent dip below the 200-Moving Average on the daily timeframe had a corresponding dip below the 10-bar Moving Average on the monthly timeframe and allowed traders to add to long positions yet again. The entry (based on the monthly 10-bar MA) level would have been somewhere around 2074.

Not “If”, But “When”

It is important to keep in mind, though, that a month-end close below the monthly 10-bar MA for the first time since December 2011 would signal a bearish trend change. It could happen two weeks from now. Or it could happen two years from now. We don’t know when it will occur. But we do know that it will occur at some point. Do not ignore the trend change signal. The last three times this bearish trend change signal occurred was December 2007 (right before the financial collapse), May 2010 (the market then went sideways for one-quarter of a year), and August 2011 (the market dropped another 12% from there and did not signal a bullish trend change until the new year began). Therefore, it would be an all-out sell signal for all the long positions that were accumulated over the last three and a half years. It would also be a green light for traders get positioned on the short side.

Gold/Silver Spread: A Failed Breakout Triggered a Short Sale Signal

Gold/Silver Spread

In the first half of last week, the December gold/silver (x7,000/oz.) spread broke out to new contract highs and knocked us out of a (hypothetical) short position. On Friday the spread closed back under the old highs, indicated that the breakout was a failure. We call this pattern a Wash & Rinse sell signal. It’s pretty powerful stuff. As a matter of fact, this triggered our reentry parameters on the short side.

Yesterday the blog reentered a hypothetical short position in the December gold/silver (x7,000/oz.) spread at approximately +$7,275 (premium gold). Initially, we are going to risk this position to a two-consecutive day close above +$10,800.

December Gold Silver (7,000 oz.) spread daily

December Gold Silver (7,000 oz.) spread daily

At the very least, this failed breakout should put the spread on a trajectory back down to the May 18th multi-month correction low at -$1,679 (premium silver). If the gold/silver (x7,000/oz.) spread is finally ready to leave the multi-month trading range, though, it could be just the start of a much larger decline. Once the May low is decisively broken, we will get a lay of the land and see if any opportunities arise to add to the short position. Given how long we’ve been wrestling with the gold/silver (x7,000/oz.) spread, we hope to really capitalize on it once a real bear market finally develops.