Kansas City/Chicago Wheat Spread: Reentry Parameters Were Elected

Jumping Back In

After the last attempt at the long side of the KC/Chicago wheat spread failed, the blog issued a setup to reenter if the March spread made a close above the declining 75-day Moving Average. This happened today.

The hypothetical long spread position was entered at -2 3/4 cents (premium CBOT wheat) by purchasing the March Kansas City wheat contract at $4.72 3/4 and selling one March Chicago wheat contract at $4.75 1/2. Initially, we are going to risk a two-day close below -29 cents (three cents below the contract low). Coincidentally, this is near the July and August lows on the nearest-futures chart.

March 2016 KC Wheat Chicago Wheat spread daily (75-day MA)

March 2016 KC Wheat Chicago Wheat spread daily (75-day MA)

The close above the 75-day MA for the first time since May signaled a bullish trend change. If the nearest-futures KC/Chicago wheat spread can now close back above the ‘even money’ mark for the first time since late June, it should confirm that the bottom is finally in.

Advertisements

Gasoline/Crude Oil Spread: Short a Reversal

Taking Another ‘Crack’ At It

Opportunities abound in the energy crack spreads, which are simply the spreads between crude oil and its derivatives of RBOB gasoline and ultra-low sulfur diesel fuel (formerly known as heating oil). When the products get too expensive or too cheap relative to the crude oil, a bet on the inevitable reversion to the mean can provide a high-probability trade.

Back in the summer, the IMC blog was stalking the RBOB gasoline/crude oil spread for a short sale opportunity. After a record duration of being in overbought territory (six consecutive months of the nearest-futures gasoline/crude ratio above 1.4:1), the spread peaked in August and plunged. Unfortunately, the reversal was so swift and volatile that the reward-to-risk ratio on the trade was no longer attractive. So after all that waiting, we pulled the plug on the trade recommendation. Sometimes, that’s just how it goes.

Driving North For the Winter

After posting a new low for the year in mid-October, the nearest-futures RBOB gasoline/crude oil spread started to recover. So far, it has gained about ten dollars as it rallied from $6.67 to $16.69.

What has our interest is the April RBOB gasoline/crude oil spread. This spread is priced another four and a half dollars higher than the nearest-futures spread. The premium is no surprise. The April delivery contracts are the first of the summer blend contract for the year, which normally trades at a premium to the winter blend contracts.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil spread daily

Technically, the April RBOB gasoline/crude oil spread is at a decision point. Then spread finished last week just above the mid-August high of $21.00, putting it at a fourteen-month high. Coincidentally, this also put it right at the major Fibonacci .618 resistance level. If the rally continues, there is no price resistance until it reaches the March 3, 2014 contract high of $24.90. Conversely, a reversal from here could send the spread several dollars lower.

A Read On the Ratio

As always, we like to take a look at the ratio of any spread that we’re stalking. This can help us clarify what’s going on and determine whether or not the spread is historically over or underpriced.

Last week the April RBOB gasoline/crude oil ratio posted a new contract high of 1.47:1. This slightly clipped the August peak of 1.46:1. Just like in the spread, the ratio may be at a make-or-break level where it needs to accelerate or it will be at risk of a sizable reversal.

April RBOB Gasoline Crude Oil ratio daily

April RBOB Gasoline Crude Oil ratio daily

Recall from previous posts that the nearest-futures gasoline/crude ratio is considered historically expensive anytime it is at 1.4:1 or higher. Then twist here is that the nearest-futures ratio is nowhere near that high. It is the summer blend April contracts that has surged ahead in anticipation.

RBOB Gasoline Crude Oil ratio weekly

RBOB Gasoline Crude Oil ratio weekly

With both the spread and the ratio of the April delivery contracts both just above their August highs, it seems that a sideways market is the lowest-probability outcome. We expect to see either a continuation or a reversal. Seasonal patterns suggest a continuation for the next couple of months. However, we want to have parameters in place to catch a reversal just in case it materializes. Consider us officially back in the hunt for the RBOB gasoline/crude oil spread.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 42,000 gallon April RBOB gasoline contract and simultaneously buying one 1,000 barrel April crude oil contract if the spread closes below $20.00. If filled, risk a two-consecutive day close of 50-cents above the 2015 high that precedes the entry.

Soy Meal/Bean Oil Spread: Roll To July Contracts

Rollin’ Along

The IMC blog has been using a reversal strategy to trade the soy meal/bean oil spread for the last several months. At the summer highs, we figures the spread was either on the cusp of a breakout that would catapult it to the 2014 summer high of +$24,726 (basis the weekly nearest-futures) or else it was finally ready to start the journey toward ‘even money’.

The breakout to new contract highs in mid-July led to a choppy trading range for a couple of months. After failing to get some upside traction, the spread started to soften. The blog then entered a short position in December soy meal/bean oil spread at approximately +$13,284 on October 2nd.

The short sale is in the black as the soy meal/bean oil spread closed at a five-month low today. However, we have to roll out of the December contracts before the First Notice Day on Monday. There’s a seasonal pattern that indicates strength is likely between now and the end of the year (the spread rallied during this time window in 14 out of the last fifteen years), but we’re going to maintain a short position and ride out the turbulence.

Just Getting Started

The reason we are going to disregard the strong seasonal patterns over the next several weeks is because we are trading with a macro view. If the seasonal rally fails to materialize, we could miss out on a chunk of the downside move that we’ve been looking for.

SoyMeal Bean Oil spread (nearest-futures) weekly

Soy Meal Bean Oil spread (nearest-futures) weekly

The soy meal/bean oil spread has spent the last three years banging around at historic highs. In the past, reversal from this level has knocked the spread back down to ‘even money’ where the soy meal contract and the bean oil contract have the same nominal value. Therefore, the recent weakness after the failed summer breakout could be just the beginning of the move south.

Since the July 2016 spread is trading at nearly the same price as the December 2015 spread, we are going to go ahead and just roll to the summer spread. This gives us a good seven months before we have to worry about rollovers again.

Trade Strategy:

On the hypothetical short position in the December soy meal/bean oil spread entered at approximately +$13,284 on October 2nd, roll to the July 2016 spread at the market-on-close on Friday, November 27th.

Continue to run the reversal system to initiate a long position (long meal and short oil) on a close above +$15,500 and a short position (short meal and long oil) on a close below +$13k. Each price level will act as a stop and reverse point.

Platinum/Gold Spread: Roll To April Contracts

This Is How We Roll

The IMC blog entered a long investment position in the January 2016-December 2015 platinum/gold spread at a price of -$200.00 (premium gold) on September 23rd. This position is backed with a bankroll of $113k. Therefore, a sell stop is not currently being used.

We’re going to add to this investment position when the spread finally makes a two-day close above the declining 75-day MA. In addition, speculative positions will also be entered when the spread makes a two-day close above the declining 75-day MA or clears the September price peak. The close above the moving average would trigger a bullish trend change and the breakout above the prior month’s high would alter the bearish price structure and confirm the trend change.

Due to next week’s First Notice Day for the December gold contract, we are going to go ahead and roll the entire spread to the April contracts. We’ll also change our entry and ‘add-on’ orders for the April platinum/gold spread as well.

Scraping the Bottom of the Barrel

After poking just above the 75-day MA at the start of the month, the platinum/gold spread gave up the ghost and plunged. By just a smidgen, the October low was breached. This puts the spread at a new record low. As a confirmation, the ratio also posted a new twenty-three year low.

The platinum/gold spread has now been inverted for ten consecutive months, making it the third-longest inversion in four and a half decades. Like a drunk uncle at the Thanksgiving table, it could be wearing out its welcome here.

Platinum Gold spread (nearest-futures) daily

platinum Gold spread (nearest-futures) daily

With the spread at the lowest price in history, the ratio at the second-lowest price in history, and the duration at the third-longest stretch in history, we think the best play is going to be on the long side. Since spreads often act like a pendulum, the current extremes could be setting the stage for a sizable move to the upside when the bear market finally ends.

Furthermore, the seasonal patterns indicate that the platinum/gold spread usually strengthens between now and the end of January. Therefore, we will stay the course with our long strategy.

Trade Strategy:

Cancel the order for the January 2016-December 2015 platinum/gold spread and place a new hypothetical order to buy two 50/oz. April platinum contracts and simultaneously sell one 100 oz. April gold contract if the April spread makes a two-day close above the declining 75-day MA (currently around -$167.00) or a one-day close above the November 6th high of -$149.10, 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:

On the long January 2016-December 2015 platinum/gold spread entered at -$200.00, sell the spread and simultaneously buy the April spread at the market-on-close on Wednesday, November 25th. Currently, there are no liquidation parameters for this low-leverage position.  

Double the position size of the investment if the April platinum/gold 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.

Copper/Gold Spread: A New Four-Year Low Was Hit.

The Metal Meltdown

On September 9th the blog entered a long position in the December copper(x2)/gold spread at +$11,625 (premium copper). The position was liquidated on November 20th at -$4,880 (premium gold), resulting in a loss of approximately -$16,505 per spread.

Copper (x2) Gold spread (nearest-futures) daily

copper (x2) gold spread (nearest-futures) daily

The two-day break below the August low was a bearish event. The spread then clipped support at the January low and finished the week at a new four-year low.

Basis the nearest-futures, support is located at the 2011 low of -$8,730 (premium gold). If the bear market does not end either side of this area, the copper(x2)/gold spread could be on a collision course with the all-time low that was posted in February of 2009 at -$29,380 (premium gold).

Potential for a Snapback

As a reminder, the copper(x2)/gold spread doesn’t usually stay inverted for very long. Even at the depths of the financial crisis, the inversion only lasted a few months. Once the bottom was established, the spread launched a two-year bull market that resulted in a rally of +$124k on a single spread. Therefore, a smart trader will step right back up to the plate and be ready to swing at the next pitch.

Copper (x2) Gold spread (nearest-futures) weekly

copper (x2) gold spread (nearest-futures) weekly

Since the March-February copper(x2)/gold spread has been inverted for a week straight, a close back above’ even money’ might be a good reentry signal. When the spread inverted in January and again in August, the recoveries back above the ‘even money’ mark sent the spread several thousands of dollars higher. Perhaps the same occurrence for the third time this year will be the charm that marks the end of the bear market.

March-Feb Copper (x2) Gold spread daily

March-Feb copper (x2) gold spread daily

A two-day close above the declining 100-day Moving Average (currently around +$5,150) should add confirmation of the trend change. The bounces into the September and November highs both petered out just before the spread tagged the 100-day MA, so a two-day close above the 100-day MA for the first time since the first half of June would trigger a bullish trend change signal in the March-February copper(x2)/gold spread.

Broader Implications

Incidentally, the fate of the copper(x2)/gold spread may be an indication of where the global economy is heading. Even non-spread traders should keep an eye on this one as it could act as a barometer for other investments. I will be expanding on this subject a bit more in a further post.

Reentry Trade Strategy:

The blog will make a hypothetical trade to buy two March copper contracts and simultaneously sell one February 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 closes above ‘even money’. Initially, the spread should be liquidated on a two-consecutive day close $500 below the contract low that precedes the entry.

Grain Basket Spread: Out With a Profit

The Basket is Now Empty

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

Today we liquidated the position at a price of approximately -23 cents (premium the sum of the wheat and corn). This resulted in a profit of approximately +$1,925 per spread, not including commissions.

Nov-Dec 2016 Grain Basket spread dailyThe narrowing range of the last few months caused us to lower our exit target to a close at -30 cents or higher. This was triggered today. Now we are going to cool our heels on this spread for a while. To get us interested in a new position, the Nov-Dec 2016 Grain Basket spread or the July 2017 Grain Basket spread will have to drop to at least -$1.00 (premium the sum of the wheat and corn) or rocket to at least +$1.50 (premium beans). If that happens, we will start forming a game plan. Until then…

Live Cattle/Lean Hog Spread: Let’s Take the Money and Run

Time to Go Vegan

On June 25th, the IMC blog initiated a short position in the December live cattle/lean hog spread at approximately 91.85. We then doubled up with another short sale at approximately 78.65 on September 2nd.

We think it may be time to get out of this meat spread for two reasons. First, we are coming into a seasonal time window where the cattle/hog spread normally rallies sharply. The spread has a tendency to rally from just after Thanksgiving to right around Christmas.

Typically, the trend in the livestock market is bearish between late November and late December. But the live cattle/lean hog spread rallies because the pigs usually fall fast than the cows.

Price Action Matters

The second -and more important- reason that we want to ‘go vegan’ with our meat spread is because of the price action.

After posting a new contract low at the end of September the December live cattle/lean hog spread surged for about a month. For the first time since early August the spread closed above resistance at the 50-day Moving Average. This indicated that the trend had turned bullish on the daily timeframe.

Also, the rally off the September low was substantially larger than all the prior bounces on the way down. Symmetrically, this is known as an ‘overbalancing of price’ and is one characteristic of a trend change.

December Live Cattle Lean Hog spread daily (50-day MA)

December Live Cattle Lean Hog spread daily (50-day MA)

The rally peaked near the Fibonacci .618 resistance line at the start of November and began to retreat. At yesterday’s close, the spread had surrendered nearly half the rally and dipped just under the 50-day MA (this prior resistance level became support once it was broken in October). Now that it’s starting to bounce this morning, it looks like a buy signal. At the very least, it would suggest that it’s time to cover our shorts.

On the weekly chart, the early July 2014 low of 67.00 was major price support. This level was broken by a full point during the last week of September when the spread closed at 66.00. The spread exploded higher the very next week, triggering a Wash & Rinse buy signal (failed bearish breakout). This corroborates the bullish trend reversal on the daily timeframe.

December Live Cattle Lean Hog spread weekly

December Live Cattle Lean Hog spread weekly

Looking at the December cattle contract on its own merit, a Wash & Rinse buy signal was triggered there as well. Yesterday the market clipped below the October 1st contract low. Today it is up sharply. This is not a time when you want to be short.

Stay Macro, My Friend

Although we are cashing in our chips on the current position, keep in mind that the live cattle/lean hog spread is still it levels that have been historically unsustainable. This means that the macro trading strategy should still be focused on the short side of this spread.

A ratio normalizes a spread relationship, so we always like to take a look at it for confirmation. Regarding the cattle and hogs, the ratio still indicates that the beef/pork spread is, indeed, still way out of whack with what is considered normal.

Live Cattle Lean Hog ratio weekly

Live Cattle Lean Hog ratio weekly

Recall from previous posts that beef is just too expensive when cattle are priced at double the price of hogs. Another way of saying this is that pork is too cheap when the cattle/hog ratio is 2:1 or higher. Either way, history shows that looking for a reversal signal somewhere above 2:1 has yielded some great short sale opportunities. At 2.44:1, the nearest-futures cattle/hog ratio is at levels only seen a couple of times in the last half century. So although we may be pulling our horns in right now, you can bet that we will be looking for a setup to short the live cattle/lean hog spread once again.

Trade Strategy:

On the short December live cattle/lean hog spread entered at approximately 91.85 and the short December live cattle/lean hog spread (the ‘add-on’ position) entered at approximately 78.65, exit right here at 75.50 or better. Also, cancel the hypothetical ‘add-on’ order to sell another spread on a close below 64.20.

Grain Basket Spread: Change the Profit Target

The Grain Basket Spread

The blog initiated a hypothetical long position in the Nov-Dec 2016 Grain Basket spread on July 14th. The position consists of one long November 2016 soybean contract, one short December 2016 wheat contract, and one short one December 2016 corn contract.

The position was entered at approximately -61 1/2 cents (premium the sum of the wheat and corn). For the last few months, we have had a standing order to exit on a close at ‘even money’ or higher. This was due to the spreads previous excursions to where beans gained the premium over wheat and corn for a few days before it rolled right back over.

When Things Change, Be Flexible

Our standing target has not yet been hit. Since Memorial Day, the Nov-Dec 2016 Grain Basket spread has peaked just above -30 cents (premium the sum of the wheat and corn) several times and then rolled over. We have to acknowledge that this is working as a resistance area.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

Furthermore, we initially bought the ‘red’ new crop Grain Basket spread when it was trading at a substantial price discount to the nearest-futures spread. The difference between the nearest-futures Grain Basket spread and the Nov-Dec 2016 Grain Basket spread has narrowed quite a bit since the summer. This gave away some of our edge. Therefore, we think it might be prudent to lower our target and look for a smaller profit.

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 -30 cents or higher instead of waiting for parity.

Feeder/Live Cattle Spread: Time To Take Profits

Corralling the Profits

The IMC blog is holding a short position in the November-December feeder/live cattle spread from the equivalent of +$41,820 (premium feeders). The November feeder contract expires next week, so we are going to go ahead and close out the position.

Still Heading South

Looking at the monthly timeframe, one can see that the feeder/live cattle spread has been in a downtrend since it peaked at a record high last year. There appears to be plenty of downside ahead. Therefore, we will now be monitoring the March-February feeder/live cattle spread for potential setups to get positioned back on the short side.

Feeder Cattle Live Cattle spread monthly (nearest-futures)

Feeder Cattle Live Cattle spread monthly (nearest-futures)

Trade Strategy:

The blog will exit the hypothetical short position in the November-December feeder/live cattle spread at the market-on-close today on November 10th.

May Soybean/Wheat spread: Reentry Parameters Triggered

Back In the Saddle

Yesterday the blog bought the May 2016 soybean/wheat spread at $3.62 1/2. This re-positioned us back on the long side after last week’s attempt was stopped out right away. We are initially going to use a two-day close below $3.40 1/2 as our exit signal.

May 2016 Soybean Wheat spread daily

May 2016 Soybean Wheat spread daily

Last week the spread cracked important price support at the September low of $3.56. The immediate reversal higher triggered a Wash & Rinse buy signal, which is a failed bearish breakdown attempt. Hopefully, this will reinforce the seasonal pattern that points higher from now thru early January.