Cocoa/Sugar Spread: Only One Week To Switch From a Multi-Year High to a Two and a Half Month Low

The Second Short Sale This Month

Today the March cocoa/sugar (x2) spread closed below the September 3rd reaction low. It also made a two-day close below the rising 50-day Moving Average for the first time since January. This triggered a short sale reentry signal for the IMC blog. Therefore, a position was initialed at today’s closing price of +$2,318.80 (premium cocoa). Initially, the short position will be liquidated on a two-consecutive day close above +$7,728 ($500 above the contract high).

March Cocoa Sugar (x2) spread daily

March Cocoa Sugar (x2) spread daily

Recall that a short sale was initiated right before the Labor Day weekend when the spread broke support at a prior month’s low and the 50-day MA. It was then knocked out just over two weeks later when a new multi-year high was hit. In the last week, the spread has gone from a multi-year high to a two and a half month low. Hopefully, this whipsaw action and surge in volatility is indicative of an end of the bull market. Regardless, we are back on the ride so you better buckle up.

Where to Now?

Historically, a run to +$4,500 (premium cocoa) on the nearest-futures monthly chart is a rare event. This current bull market is only the fifth such occasion in the last four decades. Major bear markets followed the prior four events, so we see no reason that history shouldn’t repeat.

Cocoa Sugar (x2) spread monthly

Cocoa Sugar (x2) spread monthly

The smallest of the prior four bear markets dragged the cocoa/sugar (x2) spread down to approximately -$23,000 (premium sugar). The largest bear market sent the spread to -$75,600 (premium sugar). The sizes of the bear market declines from top to bottom were approximately $104k, $39k, $32.7k, and $47.3k. Therefore, a minimum target of -$20k (premium sugar) seems to be a good initial target. Depending on the volatility and price structure, we may be able to add to the position and fully capitalize on the expected down trend. We will be posting more if anything noteworthy develops.

Advertisements

Feeder/Live Cattle Spread: Roll Out of the October Contracts

Rollover and Keep Riding the Bear Market

The blog entered a short position in the October feeder/live cattle spread at +$45,747.50 (premium feeders) on June 30th. October starts on Thursday so it’s time we roll this thing over.

Nov-Dec Feeder Cattle Live Cattle spread daily

Nov-Dec Feeder Cattle Live Cattle spread daily

The spread between November feeders and December live cattle is trading at a discount to the October spread. Nonetheless, the current level is still historically a good place to be short from. At a current price of approximately +$35k (premium feeders) we can expect another $10-15k of downside from here. Heck, anything above $15k used to be considered ‘pricey’ in the feeder/live cattle spread. Therefore, the ultimate destination of this spread could be significantly lower. Hopefully, we’ll see a few bounces of at $2-3K or more along the way. This could provide us with setups to add to the short position.

Ratio Confirmation

At today’s low of 1.65:1, the ratio between the value of one November feeder contract and one December live cattle contract is still at a level that has only been seen half a dozen times in the last half a century. This confirms that feeders are still historically overpriced in comparison to live cattle. The confirmation gives us a green light to maintain short positions and even add to them.

Nov-Dec Feeder Cattle Live Cattle ratio daily

Nov-Dec Feeder Cattle Live Cattle ratio daily

Based on the history of this ratio, it is not unreasonable to expect the ratio to return to 1.4:1 or lower. It has been two and a half years since the nearest-futures ratio has been this low. Previous monthly excursions above 1.4:1 were either side of two years in duration, so a return to 1.4:1 is overdue.

Feeder Cattle Live Cattle ratio monthly

Feeder Cattle Live Cattle ratio monthly

Furthermore, each time the ratio has reached 1.6:1 or higher it has always turned over and dropped back down to 1.3:1 or lower. It sort of acts like a pendulum where a run to one extreme end of the historic price range is often followed by a reversal that takes it back to the mean and beyond. This provides plenty of trading opportunities for the savvy spread trader.

Trade Strategy:

For tracking purposes, the blog will roll the October feeder/live cattle spread to the November feeder/December live cattle spread at the market-on-close on Tuesday, September 29th.

Platinum/Gold Spread: Investment Critera Was Elected Today

Will the Metals Test Your Mettle?

Back in late July, we posted a strategy for ‘investing’ in the platinum/gold spread with low or no leverage if it were to drop to historic extremes. With this strategy, we advocate backing it with the full value of the most expensive contract in the spread.

Jan-Dec Platinum Gold spread daily

Jan-Dec Platinum Gold spread daily

The parameters for the investment strategy were elected today when the January 2016-December 2015 platinum/gold spread dropped to -$200.00 (premium gold). The blog hypothetically purchased two 50/oz. January platinum contracts at $930.80 and simultaneously sold one 100 oz. December 2015 gold contract at $1,130.80.

This investment position is backed with approximately $113k since that is the value of 100 oz. of gold (the most expensive side of the spread). Initially, there are no liquidation parameters for this low-leverage position. Therefore, an investor should have at least in $113k in their trading account to weather any storms and avoid margin calls.

Platinum Gold spread monthly

Platinum Gold spread monthly

At a price of -$200.00, the platinum/gold spread is at the second-lowest price in history. The spread has now been inverted since mid-January. This eight-month stretch is the fourth-longest duration of inversion in the last forty-five years. As we’ve discussed in previous posts, this is unsustainable and a quick glance at a forty-year price chart makes it clear that buying at these levels are rare events. Ergo, the ‘investment’ strategy for the spread.

Ratio Confirmation

In addition to the historically low spread price, the ratio between platinum and gold dropped to a thirty year low of 0.82:1.

Platinum Gold ratio weekly

Platinum Gold ratio weekly

In the last four decades, only a two-month period between August and October 1982 ever experienced a lower ratio than todays. This confirms that the current level should be a temporary outlier. Investors and traders armed with this knowledge really have an edge to exploit here.

Upping the Ante

For investors who are willing to take the risk, it makes sense to increase the position once the initial investment is showing a profit. If the bullish trend change signal the blog is using for the entry signal is elected, it would be a logical time to add to investment.

However, since the ‘add-on’ position would increase the leverage factor, investors should give it a shorter leash than a trader might for an exit. Failure to keep the upside momentum after a trend change would be a good reason for investors to at abandon the ‘add-on’ spread and cut the leverage back. You don’t want to see your staying power erode for the initial investment.

Making History

Historically, many hedge funds, CTAs, famous traders, etc. earned their fame and fortune by nailing a major event. Counter-intuitively, it was accomplished by not diversifying. It demanded all of their focus. It required a significant amount of their capital. In some cases, it also tied up years of their time. This took patience, confidence, excellent money management, and the guts to stick to the plan. Weakness in any of these attributes could spell financial disaster.

This sort of campaign trading and investing is certainly not for everyone. As a matter of fact, we strongly believe that the majority of people who trade or invest in the markets shouldn’t even think about it! But those select few that are cut from the same risk-taking cloth as the greats (Jesse Livermore, George Soros, Paul Tudor Jones, etc.) may have an opportunity here in the platinum/gold spread. We hope to read about you in the next Market Wizards book.

Trade Strategy:

The IMC blog is currently working a hypothetical order to 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 -$121.00) or a one-day close above the September 3rd high of -$114.00, whichever occurs first. 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.

Investment Strategy:

Hold the long January 2016-December 2015 platinum/gold spread entered at -$200.00. Currently, there are no liquidation parameters for this low-leverage position.

Double the position size if the spread makes a two-day close above the declining 75-day MA. If filled, liquidate the ‘add-on’ position if the spread makes a on a two-day close below the declining 75-day MA.

Cocoa/Sugar Spread: New Multi-Decade Highs Sends the Short Sale Campaign To the Sidelines…For Now

New Contract Highs Means “Don’t Be Short!”

Hypothetically, the IMC blog entered a short position in the December-October cocoa/sugar (x2) spread at +$6,435.20 (premium cocoa) on September 4th. Dues to the breakout to new highs, the position was exited at +$8,626.80 (premium cocoa) on September 21st. Non including commissions, this booked a loss of -$2,191.60 on the trade.

Despite the loss, the spread is still a candidate for a short sale. As a matter of fact, it is even more qualified. This is because the cocoa/sugar (x2) spread is reaching new highs that have not been seen since the 1980s and is now at a level that has only been surpassed twice in half a century. This morning’s ratio of 2.72:1 is the highest ratio since 2002 and also a historically unsustainable level.

New Parameters

With the October sugar contract set to expire in just a couple of weeks, we are going to move out to the March spread for the next trade attempt.

March Cocoa Sugar (x2) spread daily

March Cocoa Sugar (x2) spread daily

The September 3rd correction low sets the current low for the month. This is an important technical support level since it is the only place since January where the March cocoa/October sugar (x2) spread broke below a prior month’s low. It was also the only time since early February where the spread has made a close below the rising 50-day Moving Average. If it’s breached, the spread will immediately be on the defensive. Therefore, a break of the current September low or a two-day close below the 50-day MA for the first time since Q1 would be a logical technical signal to get repositioned on the short side.

Trade Reentry Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 10-ton March cocoa contract and simultaneously buying two 112,000 lb. March sugar contracts if the spread close below the September 3rd reaction low of +$3,590 (premium cocoa) or makes a two-day close below the 50-day MA (currently around +$4,495), whichever occurs first. Initially, the new position will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.

Copper/Gold Spread: The Last Three Trend Change Signals Were Correct. How About This One?

Pedal to the Metal

At yesterday’s close, the December copper(x2)/gold spread closed above the declining 50-day Moving Average for two consecutive days. This triggered a bullish trend change. The blog initiated a hypothetical trade by buying two December copper contracts at 243.65 (total contract value of $121,825) and simultaneously selling one December gold contract at $1,102.00 (contract value of $110,200). This establishes a long position at +$11,625 (premium copper). Initially, the exit strategy is to liquidate the spread on a two-consecutive day close below -$3,000 (premium gold).

December Copper (x2) Gold spread daily

December Copper (x2) Gold spread daily

If recent history is any indication, the spread should now rocket several thousand dollars higher. This is the fourth trend change signal that has been triggered by way of a two-day close above/below the 50-day MA since late November. The three prior signals were all accurate and followed by moves of $17k to $34k.

Furthermore, history shows that the copper(x2)/gold spread has always recovered after experiencing an inversion. The inversion in January was followed by a run to nearly +$29k by early May. A return to this level could be a minimum expectation. If this level is surpassed, the spread may have the potential to make a run for the late 2013 peak near +$50k.

Kansas City/Chicago Wheat Spread: Is the Bottom In?

The Inversion May Be Over

The December KC/Chicago wheat spread closed at +7 cents (premium KC wheat) on September 4th. This put the spread above the August 31st bounce high. It was also the first close above the declining 50-day Moving Average since mid-May. Therefore, the blog initiated a hypothetical long position right on front of the holiday weekend. We will initially risk a two-day close below -14 1/4 cents (premium CBOT wheat).

December KC Wheat Chicago Wheat spread daily

December KC Wheat Chicago Wheat spread daily

After an inversion, the KC/Chicago wheat spread normally returns to where KC wheat has a premium of 35 cents or more over the Chicago wheat. It would not take much for the spread to return to this level. Once it does, we will have to decide whether or not to just bag the profit or hang on for more potential upside. We will simply monitor the price behavior to make this decision.

Cocoa/Sugar Spread: Is the Bull Market Finally Over?

Bearish Trend Change?

Last week the December-October cocoa/sugar (x2) spread made a two-day close below the rising 50-day Moving Average for the first time in over seven months. Furthermore, the spread broke below a prior month’s low for the first time since January. This altered the bullish price structure and triggered a bearish trend change signal.

Dec-Oct Cocoa Sugar (x2) spread daily

Dec-Oct Cocoa Sugar (x2) spread daily

The IMC blog initiated a short position on September 4th when the spread between the value of one December cocoa futures contract and the sum of the value of two October sugar futures contracts closed at +$6,435.20 (premium cocoa). Initially, the exit strategy is to liquidate the spread on a two-consecutive day close above +$8,345.

Looking Ahead

Over the last forty years, there were only four other times when the nearest-futures cocoa/sugar (x2) spread rallied above +$4,500 (premium cocoa) on the monthly chart and then rolled over. The smallest bear market that followed pushed the spread down to just below -$23,000 (premium sugar) and the biggest bear market that followed pushed the spread down to -$75,600 (premium sugar). The sizes of the bear market declines from top to bottom were approximately $104k, $39k, $32.7k, and $47.3k. So if this really is the end of the multi-year run higher, we have a lot of room to build up a short position to take full advantage of the coming bear market.

Cocoa Sugar (x2) spread monthly

Cocoa Sugar (x2) spread monthly

Live Cattle/Lean Hog Spread: An ‘Add-On’ Trade Was Elected. More To Come!

Just the Beginning?

Yesterday the December live cattle/lean hog spread closed below 80.00 (premium cattle) and triggered the ‘add-on’ entry criteria. Therefore, IMC blog sold another December live cattle/lean hog spread at approximately 78.65. Initially, we will liquidate the spread on a two-day close above 85.00.

Live Cattle Lean Hog ratio monthly

Live Cattle Lean Hog ratio monthly

Even though the ‘add-on’ was entered with the spread at a six-month low and the ratio at a three month low, the long-term charts indicate that we’ve barely scratched the surface of the potential bear market here. The December cattle/hog ratio closed at 2.22:1 yesterday. When you look at the last forty-five years of price history, you will see that there was only the fifth time that the ratio has ever been above 2:1! To get back somewhere close to normal, the ratio has a long, long way to go. This could be one heck of a trading opportunity if we can continue to add to the position as the trend unfolds. The IMC blog will be actively monitoring the situation to see if more ‘add-on’ short sale setups will materialize.

Kansas City/Chicago Wheat Spread: About To Go On a Tear?!

Protein Makes a Difference

Although the Chicago wheat contract is the world benchmark for wheat prices, the Minneapolis and Kansas City wheat contracts normally trade at a premium to the CBOT wheat. This is because the Minneapolis hard red spring wheat and Kansas City hard red winter wheat are a higher protein content and, therefore, higher quality product that the CBOT soft red winter wheat. The Minneapolis and Kansas City wheat is what buyers purchase for food production.

KC Wheat Chicago Wheat overlay monthly

KC Wheat Chicago Wheat overlay monthly

As you would probably suspect, the price behavior of these three wheat contracts are highly correlated. However, there are times when one or two of the markets will outperform the other. This is where the spread opportunity lies.

Historical Boundaries

Normally, the Kansas City wheat contract will have a markup of roughly 10% over the CBOT wheat contract. At ‘normal’ levels, you can flip a coin to determine which way the spread will go. There’s not much of an edge at this level so we ignore it.

Our antennas go up when KC wheat climbs to a premium of 20% or more over the CBOT wheat. This has happened about a handful of times in the last four decades. It never lasted. This indicates that a premium of 20% or more makes the KC/Chicago wheat spread a short sale candidate.

KC Wheat Chicago Wheat ratio monthly

KC Wheat Chicago Wheat ratio monthly

On the other side of the coin, we start getting interested in the long side of the trade when Chicago wheat starts trading at a premium to KC wheat and we start getting involved when CBOT reaches a premium of 5% or more. At that point, the KC/Chicago wheat ratio is at 0.95:1 or lower. This has only happened twice in the last decade and a little more than half a dozen times in the last forty-five years. Ultimately, things would reverse and Kansas City wheat would go back to trading at a 10% premium over CBOT wheat. In price terms, the KC wheat would normally go back to a premium of 35 to 40 cents or more over the Chicago wheat.

The Current Situation

Thanks to the rains that pounded the Midwest right before the harvest, the soft wheat growing region suffered a drop in crop size. This is in addition to the fact that the seeded area was already below the five-year average.

KC Wheat Chicago Wheat spread monthly

KC Wheat Chicago Wheat spread monthly

This direct hit to the soft wheat crop allowed the Kansas City wheat to fall well below the price of the CBOT wheat. The nearest-futures spread dropped into the red (pun intended) by more than 20 cents. This has only happened half a dozen times in nearly half a century of trading. This has been a great buying opportunity in the past, so that’s the side of the trade we want to focus on.

The spread between the December contracts did not sink as low as the nearest-futures September contract, but it still inverted. This qualifies it as a trade candidate.

On August 31st the December KC/Chicago wheat spread closed with the KC wheat at a premium for the first time in nearly four weeks. The spread then backed off.

December KC Wheat Chicago Wheat spread daily

December KC Wheat Chicago Wheat spread daily

The declining 50-day Moving Average is now in close proximity to the August 31st bounce high. A breakout above the August 31st bounce high of +2 3/4 cents (premium KC wheat) and a close above the 50-day MA for the first time since mid-May would signal a bullish trend change for the spread. This could indicate that the inversion is over and that a return to normal is underway. If so, spread traders would have a good reason to get positioned on the long side.

Trade Strategy:

We’re going to work a hypothetical order to buy one December Kansas City wheat contract and simultaneously sell one December Chicago wheat contract if the spread closes at +3 cents (premium KC wheat) or higher. If filled, we will initially risk a two-day close of three cents below the contract low that precedes the entry.