Gasoline/Crude Oil Spread: Change the Entry Parameters

The IMC blog is currently working a hypothetical order to short the October RBOB gasoline/crude oil spread on a two-day close below the rising 75-day Moving Average. This could happen today since the spread closed below the 75-day MA yesterday for the first time since late January. Given the fact that the RBOB gasoline/crude oil ratio has been above 1.4:1 for a record duration, we expect the bearish trend change to cause a fast and potentially violent decline.

October Gasoline Crude Oil spread daily

October Gasoline Crude Oil spread daily

The problem, however, is that the spread has dropped nearly eight dollars from the high it posted two weeks ago. This wiped out more than half of the entire advance from the January low to the August high. It means that a short sale near the current price level with a risk to new highs would be a risk of more than eight dollars. To even get a reward-to-risk expectation of 2:1 the spread would have to invert and price gasoline nearly three dollars below the price of crude oil! That’s only happened once in history and it’s certainly a low-probability bet.

Furthermore, while the spread is crashing below the 75-day MA the ratio is just now approaching it. This last two times the ratio pulled back to the 75-day MA was in April and June. Both times, it rebounded and soared to new highs. Until the ratio makes a two-day close below the 75-day MA we have to view it as a test of support and a good chance that a bounce could materialize.

October Gasoline Crude Oil ratio daily

October Gasoline Crude Oil ratio daily

In light of the current circumstances, it makes sense to cancel the short sale below the 75-day MA and look to sell short on a bounce instead. A rebound to somewhere around the Fibonacci .618 retracement of the current decline would be an ideal target to short on a bounce. If the spread can at least make a minimum bounce to the Fibonacci .382 resistance line we can also work orders to sell on a break to new corrective lows and risk above the high of the bounce. Therefore, we are going to adjust the strategy.

As a note of interest, we are currently experiencing only the second time in the last decade when gasoline at the pump is above $2-per-gallon while crude oil is priced below $40-per-barrel. With the futures ratio just coming off of record highs, everything is in place for a major decline. In the event that we actually do see gasoline spill below the price of crude, you can bet that we will be looking for a major buying opportunity!

Trade Strategy:

Cancel the current hypothetical order to short the October RBOB gasoline/crude oil spread on a two-day close below the rising 75-day MA. Work a new contingency to sell one 42,000 gallon October RBOB gasoline contract and simultaneously buy one 1,000 barrel October crude oil contract if the spread rallies to $17-per-barrel. If filled, liquidate on a two-consecutive day close above $21.80.

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Gold/Silver Spread: Another Breakout, Another Stop Out

Gold/Silver Spread

On July 10th, The IMC blog initiated a hypothetical short position in the December gold/silver (x7,000/oz.) spread (short a 100 oz. gold contract, long a 5,000 oz. silver contract, and long two 1,000/oz. ‘mini’ silver contracts) at +$7,275 (premium gold). The position was liquidated yesterday at the close at +$11,273 (premium gold), resulting in a hypothetical loss of -$3,998. The exit criterion was triggered by the two-consecutive day close above +$10,800.

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

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

The bullish breakout was confirmed by a breakout to new multi-year highs in the gold/silver ratio as well. This morning the ratio reached 79:1. This upside is likely due to the fact that silver has been punished like an industrial metal during the current market meltdown while gold has somewhat stabilized.

December Gold Silver ratio daily

December Gold Silver ratio daily

Until a reversal pattern materializes, the gold/silver (x7,000/oz.) spread does not have any price resistance until it reaches the 2008 all-time high of +$13,519 and the gold/silver ratio does not face resistance until it reaches the 2008 weekly spike high of 84:1.

For now, the blog is flat on the gold/silver (x7,000/oz.) spread. We will continue to monitor this spread, but we need to see some sort of setup start to take shape before we can create reentry parameters.

Copper/Gold Spread: Almost Time To Prefer Redheads Over Blondes?!

Precious Metals and Industrial Metals Are Correlated

Although gold is considered to be a precious metal and copper is strictly an industrial metal, the two markets show a surprisingly strong correlation on the long-term timeframe. Over the last three decades, these two markets have generally trended in the same direction. Fundamentally, this could be due to the fact that inflation and global economic growth influence both markets.

Copper Gold overlay monthly

Copper Gold overlay monthly

 

The Gold/Copper Spread

Since the 2011 peak in commodity prices, both copper and gold have been in multi-year bear markets. Copper has taken the bigger hit as China, the world’s largest consumer of copper, is experiencing the slowest economic growth in decades. The recent stock market meltdown accelerated the move to the downside and smashed the copper/gold spread to historically low levels.

Copper (x2) Gold spread monthly

Copper (x2) Gold spread monthly

At yesterday’s close, the value of two December copper contracts was worth nearly $3,000 less than the value of one December gold contract. Over the last thirty years, there have been less than half a dozen times when two copper contracts were valued at a discount to the value of one gold contract. Normally, a pair of copper contracts should have a premium of $15-20k or more over a single gold contact. This indicates that a buying opportunity could be shaping up.

The Gold/Copper Ratio

December Gold Copper ratio daily

December Gold Copper ratio daily

To normalize the relationship between these two metals, take a look at the ratio. The ratio between the value of a December gold contract and a December copper contract reached 2.05:1 yesterday, which is just below the January peak of 2.10:1. A reversal from here could establish a double top on the daily timeframe.

Gold Copper ratio monthly

Gold Copper ratio monthly

More importantly, history shows that a ratio of 2:1 or higher is a rare event and one that is unsustainable. On the monthly timeframe, we can see that the ratio hit nearly 3:1 back in 1987. Since then, however, there have only been a half-dozen times when the ratio made it up to 2:1 and the 2009 peak of 2.53:1 was the only time when it was significantly surpassed. Even then, it only lasted a few months before the ratio reversed and crashed back to earth. The takeaway from this is that a ratio of 2:1 or higher indicates that a major reversal is at hand. We are there now.

The Current Technical Pattern

The December copper(x2)/gold spread has been in a multi-month decline off the May 1st top. It is closing in on the January multi-year low where it has the potential to establish a double bottom or even trigger a Wash & Rinse buy signal.

December Copper (x2) Gold spread daily

December Copper (x2) Gold spread daily

The spread has closed below the declining 50-day Moving Average every single day for nearly a quarter of a year. The 50-day MA has been an accurate trend indicator since Thanksgiving. A two-day close below the 50-day MA in late November led to a $34k drop into the late January low. A two-day close back above the 50-day MA in late February (for the first time in three months) saw follow-through of an additional $17k into the May Day top. The two-day close back under the 50-day MA in late May (for the first time in three months) has pushed the December copper(x2)/gold spread another $19k lower so far. Therefore, a two-day close back above the 50-day MA for the first time in at least three months may be our cue to climb aboard the long side of the trade.

Trade Strategy:

The blog will make a hypothetical trade to buy two December copper contracts and simultaneously sell one December gold contract if the spread between the value of the sum of two 25,000 lb. copper contracts and the value of one 100 oz. gold contract makes a two-day close above the declining 50-day Moving Average. Initially, the spread should be liquidated on a two-consecutive day close below the contract low that precedes the entry.

Euro Bund/T-note Spread: A Short Sale Signal Was Triggered

The Euro Bund/T-note Spread

Yesterday the December Euro bund/T-note spread closed below the August 5th low and triggered a short sale signal. The blog entered a hypothetical short position when it sold one December Euro bund contract at 155.99 and simultaneously bought one December T-note contract at 128-20. This puts the spread on at a price of 27.36 (premium bunds). Initially, the spread will be liquidated on a two-consecutive day close above 28.57 (10 ticks above last month’s peak).

December Bund T-note spread daily

December Bund T-note spread daily

Technically, this was an ideal place for the spread to roll over. The rally took it to the Fibonacci .618 resistance line and just above the 100-day Moving Average. Yesterday’s carnage in the global stock market tripped the wire for the trend change. Interestingly, today’s rebound (so far) in stocks did not cause a rebound in the Euro bund/T-note spread. Instead, it broke even lower as the bunds are dropping faster than US Treasuries. This is certainly a good way to start the trade.

Once the December Euro bund/T-note spread breaks below the June multi-month low of 24.97, it should confirm that a second leg down is underway. This should give us a big enough open profit on the short position to start looking for an ‘add-on’ setup. We’ll keep you posted.

Euro Bund/T-note Spread: Will We See Another Leg Down?

The Euro Bund/T-note Spread

Previously, the blog has demonstrated that a strong correlation exists between the Euro bund (10-year duration) and the US T-note (10-year duration). We have also shown that periods exist where the two markets diverge or alternate leadership. In some cases, this pushed the spread to historically unsustainable levels where the knowledgeable trader could prepare to capitalize on a reversal. It is possible that we are seeing this occur right now.

Bund T-note Overlay Monthly

Bund T-note Overlay Monthly

Fundamentally, we are still seeing a divergence between European and US monetary policy. While the question over here is one of “when” and not “if” the Fed will start hiking rates, the ECB continues to operate in a negative interest rate environment as there seems to be no light at the end of their economic tunnel. This is the catalyst that drove the European 10-year yields to multi-decade lows against the American counterpart and put the spread at a record high. However, history indicates that this will not last forever. If the Euro bund/T-note spread rolls over again, it would suggest that the divergence in monetary policy may be coming to an end.

 

A Second Chance?

In the first quarter of the year, the Euro bund/T-note spread peaked out at new all-time highs. The reversal that followed was quick and volatile. Traders who did not act immediately were left in the dust. But after bottoming out in mid-June, the spread began a major bear market rally. This put it back on the watch list for a potential short sale.

On the nearest-futures chart, the Euro bund/T-note spread recently closed back above the 100-day Moving Average for the first time since April. When the 100-day MA was decisively broken in April for the first time in over sixteen months it led to the dramatic decline. The current rebound to the 100-day MA puts the spread at a decision point. This is either where we see confirmation that the selloff was merely a sharp correction in a multi-year bull run or else we should see another reversal and expect a new decline to a lower low than what we saw in June.

Bund T-note Daily (nearest-futures)

Bund T-note Daily (nearest-futures)

From a technical view point, the Fibonacci .618 retracement of the entire decline should mark resistance for the current rally. That level is located at 28.46. Although the nearest-futures spread has not yet reached this level, the December Euro bund/T-note spread has. This would be an ideal place for the summer rally to end.

Trade Strategy:

The blog will make a hypothetical trade by shorting one December Euro bund contract and simultaneously buying one December T-note contract if the nearest-futures spread makes a two-day close below the 100-day Moving Average (currently at 27.00) or the December spread breaks the August 5th low of 27.44. Initially, the spread should be liquidated on a two-consecutive day close 10 ticks above the high of this current rally from the June low.

Note: The risk is a somewhat of a moving target since the Euro bund contract is denominated in Euros and the T-note contract is denominated in US dollars. A full point move in the bund equals 1,000 Euros and a full point move in the T-note equals $1,000. At the current exchange rate of approximately 1.105 the price fluctuations in the bund are about 10.5% greater in value than the price fluctuations in the T-note. A large trader can equalize this by trading eleven T-note contracts against ten Euro bund contracts. A ‘one-lot’ trader, however, needs to stay aware of the how the exchange rate differential is impacting the P/L on the spread trade.

Gasoline/Crude Spread: Switch to October Contracts

RBOB Gasoline/Crude Oil Spread

The September crude oil contract expires in a week, so we are going to switch from stalking the September RBOB gasoline/crude oil spread to stalking the October spread. Although the October spread is trading at a discount to the September spread, it still qualifies as a short sale candidate. The ratio for the October contracts is closing in on 1.5:1. Remember, anytime the ratio hits 1.4:1 or higher it is at historically unsustainable levels.

October Gasoline Crude Oil spread daily

October Gasoline Crude Oil spread daily

We are continuing to use a two-day close below the rising 75-day Moving Average as our short sale signal. This has not occurred since late January. Furthermore, a break below a prior month’s low for the first time since early April low will alter the current bullish price structure and confirm the bearish trend change.

Trade Strategy:

Cancel the current hypothetical order in the September RBOB gasoline/crude oil spread and replace it with a new order to sell one 42,000 gallon October RBOB gasoline contract and simultaneously buy one 1,000 barrel October crude oil contract if the spread makes a two-day close below the rising 75-day MA (currently around $16.43). If filled, the spread will initially be liquidated on a two-consecutive day close 20 cents above the 2015 high that precedes the entry.