Gasoline/Crude Oil Spread: Entry Signal and Bearish Trend Change

In the Tank

Yesterday the April RBOB gasoline/crude oil spread closed below the December 22nd correction low and triggered an entry signal for the blog. A hypothetical short position was initiated by selling one 42,000 gallon April RBOB gasoline contract at $1.2612 (the equivalent of $52.97-per-barrel) and simultaneously buying one 1,000 barrel April crude oil contract at $31.38. This put the entry price on the spread at $21.59.

Initially, we will risk a two-consecutive day close above $25.73. This is 50-cents above the contract high.

Favorable Charts

The chart action preceding the short sale is ideal. Recall that the spread started the year with a breakout to new highs. It then quickly retreated, signaling a failed breakout.

Furthermore, the spread breached the mid-December pullback low on Friday. This is the first time that a prior correction low has been breached. It’s another sign of a bearish trend change.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil spread daily

Hopefully, we’ve nailed the trend reversal on the first attempt. If so, we will be watching for setups to add to a short position. It would make sense to take full advantage of a winning trade and compound it. In the event that we’re wrong, our exit criterion is already in place. Now it’s up to the market to tell us whether we are right or wrong.

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Bean Oil/Corn Spread: Nice Run! Let’s Lock In Profits.

Nice Ride, Bro

A hypothetical long position in the July 2016 bean oil/corn spread was entered at -$2,760.50 (premium corn) on October 9th. The blog was initially risking a two-day close $200 below the September 15th contract low.

In the last part of December, the bean oil contract finally regained a premium over the corn contract. This took the spread to the highest level in six months. It’s not too far from price resistance at the 2015 high of +$1,087.50.

During this climb from the September low, the spread has made two noteworthy pullbacks before resuming the rally. The most recent was the dip into the December 17th low of -$837.50. New multi-month highs followed shortly after. Therefore, the mid-December low is near-term price support.

July Bean Oil Corn spread daily

July 2016 Bean Oil Corn spread daily

Additionally, the rising 50-day Moving Average will soon reach the December 17th low. The spread has not closed below the 50-day MA since early October. A two-day close below the 50-day MA and a break of the mid-December low could indicate that the run is over. Therefore, we advocate exiting stage right if that happens. Like the song says, “Go on, take the money and run”.

Trade Strategy:

On the hypothetical long position in the July 2016 bean oil/corn spread entered at approximately -$2,760.50 on October 9th, exit on a two-day close below the 50-day Moving Average.

Copper(x2)/Gold Spread: Reentry Adjustment

To the Point

We posted reentry criteria for a long position in the March-February copper(x2)/gold spread last week. First Notice Day for the gold contract will be here in a couple of weeks, so we’re going to go ahead and buyer longer-dated contracts for both metals.

May-June Copper (x2) Gold spread daily with 100-day MA

May-June Copper (x2) Gold spread daily with 100-day MA

We’re working to buy back in if the May-June copper(x2)/gold spread can make a two-day close above the declining 100-day Moving Average for the first time since the first half of June or if it can clear the late December bounce high.

The Copper/Gold Ratio: It’s Getting Interesting

The ratio between the value of one 25,000 lb. copper contract and one 100 oz. gold contract has dwindled to a nearly seven-year low of 0.45:1. In the event that the ratio matches the financial crisis low of 0.35:1, we may alter the position to buy three copper contracts for every one gold contract sold short. This will help normalize the position since one copper contract would be approximately one-third of the value of one gold contract.

Copper Gold ratio (nearest-futures) weekly

Copper Gold ratio (nearest-futures) weekly

Incidentally, the copper/gold ratio has only been as low as 0.35:1 three times in the last four decades. It turned out to be a phenomenal buying opportunity. Maybe we’ll get lucky and have another chance to get that same bargain price in 2016…

Reentry Strategy:

Cancel the hypothetical order for the March-February copper(x2)/gold spread and place a new order to buy two May copper contracts and simultaneously sell one June 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 100-day MA or a one-day close above the December 30th rally high of +$1,480. Initially, the spread should be liquidated on a two-consecutive day close $500 below the contract low that precedes the entry.

Soy Meal/Bean Oil Spread: Lock In the Profits

Lock In Profits

The IMC blog is currently short the July soy meal/bean oil spread from the equivalent of +$13,498. The position was entered on October 2nd in the December contracts and rolled over.

Historically, the soy meal/bean oil spread has a good track record of returning to the ‘even money’ level after an outlier excursion to the upside. This remains our macro target.

Near-term, the spread almost matched the 2015 low at the end of last month. It started the New Year with a rally past resistance at the mid-December bounce high. This is bullish behavior.

July Soy Meal Bean Oil spread daily

July 2016 Soy Meal Bean Oil spread daily

If the July soy meal/bean oil spread makes a two-day close above the declining 50-day Moving Average (currently around +$10,441) for the first time since mid-September it would trigger a bullish trend change. It may be prudent to cover the short position and book our profits if that happens. If so, we will get to the sidelines and look for a place to reenter.

Trade Strategy:

On the hypothetical short position in the July soy meal/bean oil spread entered at approximately +$13,498 on October 2nd, exit on a two-day close above the 50-day Moving Average.

Platinum/Gold Spread: Exit and Reentry Criteria

That Was Quick

The IMC blog entered a long position in the April the platinum/gold spread at -$176.50 (premium gold) on December 29th. The position was liquidated at -$246.80 on January 12th. This resulted in a loss of -$7,030 per spread, not including commissions.

The long position was initiated when the spread made a two-day close above the declining 75-day Moving Average for the first time in a year and a half. The breakdown to new all-time lows prompted us to get out.

It took less than two weeks for the spread to go from a nearly two-month high to a new all-time low. After that whipsaw, we are going to recalibrate our trend change criteria and use a slower moving average.

Platinum Gold spread (nearest-futures) daily with the 100-day MA

Platinum Gold spread (nearest-futures) daily with the 100-day MA

Instead of a 75-day MA, we will now track the 100-day MA on the platinum/gold spread. The spread got just above the declining 100-day MA on December 31st before it turned around and collapsed. We haven’t seen a two-day close above the 100-day MA since August of 2014. Therefore, we will wait for this to happen before we throw our hat back in the ring.

The Ratio

Although the spread hit new record lows, the ratio has not yet matched its record low. Basis the nearest-futures, the platinum/gold ratio hit 0.77:1 this week. This put it just a stone’s throw from the October 1982 all-time low of 0.69:1. It will be interesting to see if the ratio establishes a double bottom around this area.

Platinum Gold ratio (nearest-futures) weekly

Platinum Gold ratio (nearest-futures) weekly

Growing Old

The price inversion of the platinum/gold spread turns one-year-old tomorrow. If it does not see a radical turnaround before the first half of March is over, this will be the second-longest duration of platinum trading at a discount to gold.

The longest stretch of an inverted spread was nineteen months. To match this record, the platinum/gold spread will have to stay inverted until mid-August. That’s always a possibility. If China does not recover and the US dollar stays at multi-year highs, commodities could remain under pressure. Heck, who’s to say the spread won’t make a new time record?

The one thing we can say is that record extremes -both in terms of price and time- are usually followed by major reversals in the opposite direction. May times, the reversal acts like a pendulum in that it swings from one extreme to the other. So when the bear market in the platinum/gold spread finally gives up the ghost, we may be looking at a bull market that carries it well beyond the historic mean. The trick, of course, is to manage risk while we wait for the inevitable reversal. Play good defense right now. Once the trend finally reverses and the ball is in our court, we can get aggressive.

Reentry Strategy:

Buy two 50/oz. April platinum futures contracts and simultaneously sell one 100 oz. April gold contract if the spread makes a two-day close above the declining 100-day MA or a one-day close above the December 31st bounce high of -$167.60, 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.

Gasoline/Crude Oil Spread: Raise the Entry Price

Still Rocketing Higher

The IMC blog has been tracking the RBOB gasoline/crude oil spread for a short sale. We switched to stalking the April spread in November to buy more time and to take advantage of the significant price mark-up for the first of the summer blend contract for 2016.

The April spread is priced more than eight dollars over the nearest-futures February spread. This is a big deal as it represents $8,000 more on a single spread.

Since bottoming in mid-October, the April RBOB gasoline/crude oil spread has been on quite a tear. Despite the fact that crude oil tanked to the lowest price in a dozen years, the RBOB gasoline/crude oil spread is actually moving higher. This is because the RBOB is not dropping as fast as the crude. The New Year kicked off with a breakout to a new contract high of $25.22. This marginally surpassed the prior contract high of $24.90, which was set on March 3, 2014.

A twenty-five dollar premium on the gasoline side of the spread is pretty pricey. Over the last three decades, there have been seven occasions where the nearest-futures spread reached $25.00 (premium gasoline) or higher on the monthly timeframe. Each instance preceded a great short sale opportunity. Right now, though, it pays to own a refinery. I hope they are saving up their cash because this fat profit margin won’t last forever.

RBOB Gasoline Crude Oil spread (nearest-futures) monthly

RBOB Gasoline Crude Oil spread (nearest-futures) monthly

Although the April spread hit $25.22 this week, the nearest-futures RBOB gasoline/crude oil spread only made it to $17.45. It’s currently trading under fifteen dollars, so traders who just monitor the front month spreads may not be aware that the summer spreads have reached historically expensive levels. Perhaps this is a hidden opportunity for us?

The Ratio

April RBOB Gasoline Crude Oil ratio daily

April RBOB Gasoline Crude Oil ratio daily

What really has me salivating as a short seller is the fact that the April RBOB gasoline/crude oil ratio also posted a new contract high this week. The ratio actually broke out to new contract highs at the start of December and it has continued to climb since then. This week it closed at a nosebleed level of 1.65:1.

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

RBOB Gasoline Crude Oil ratio (nearest-futures) monthly

Let’s get a perspective of just how high the April ratio is. History shows that the ratio is expensive anytime it reaches 1.4:1 or higher. On a monthly closing-basis, the RBOB gasoline/crude oil ratio has reached 1.4:1 or higher less than a dozen times in three decades. And there has only been one time ever when the ratio has reached 1.65:1 or higher on a monthly closing-basis (it topped at 1.67:1 last February).

Once again, it is true that the April ratio is trading at a significant premium over the nearest-futures ratio. But this seasonal carry-charge may be a gift for short-sellers. It sure beats looking for a setup to get short at a substantial discount in order to get more time.

Will a Reversal Materialize?

The April RBOB gasoline/crude oil spread cleared the 2014 contract high this week. It then broke lower immediately. This Wash &Rinse sell signal is a failed breakout pattern. The implications are that the top could be in place.

Since bottoming in mid-October, the spread has been in an uptrend with higher highs and pullbacks into higher lows. It pulled back $2.11 from the November 9th high, $1.84 from the early December 1st high, and $2.76 from the early December 11th high. A pullback that’s noticeably more than three dollars off the high could constitute an overbalancing of price and confirm that the trend has changed.

April RBOB Gasoline Crude Oil spread daily

April RBOB Gasoline Crude Oil ratio daily

After the spread traded a dime away from the contract high in early December, it made a sharp pullback to $22.04 on December 22nd. From there it was able to take another stab at new highs. The December 22nd correction low is now a key price support level to watch. If this level is breached, it will be the first time during this run that a prior correction low was broken after new rally highs were made. This would certainly justify a short sale.

Trade Strategy:

On the hypothetical order to sell one 42,000 gallon April RBOB gasoline contract and simultaneously buying one 1,000 barrel April crude oil contract, raise the entry price two dollars from a close below $20.00 to a close below $22.00. If filled, risk a two-consecutive day close of 50-cents above the contract high that precedes the entry.

Feeder/Corn Spread: Reentry Signal Triggered

Back In the Rodeo

The IMC blog reentered the short side of the feeder/corn spread today when April feeder cattle broke support at last week’s low.

The short position was entered by selling one 50,000 lb. April feeder cattle contract at 158.325 (contract value of $79,162.50) and simultaneously buying five 5,000 bushel May corn contracts at $3.62 1/2 (a total contract value of $90,625). Therefore, the position is short from -$11,462.50 (premium the sum of the five corn contracts). The initial exit criteria will be to liquidate on a two-consecutive day close above -$6,462.50 (premium corn).

April Feeder Cattle weekly

April Feeder Cattle weekly

As noted in the prior post, the break below a previous week’s low in feeders would indicate that the bear market rally is over. The fact that it happened after testing resistance at the declining 50-day Moving Average (basis the nearest-futures) was already a good sign, but the fact that it resulted in an ‘outside bar’ with a downward reversal on the weekly timeframe is even better. If this is the resumption of the downtrend for the spread, we will be watching for opportunities to add to the position.

Copper(x2)/Gold Spread: Exit Signal Triggered

Bears Maul the Commodity Spreads

On December 29th the blog entered a theoretical long position in the March-February copper(x2)/gold spread at +$25 (premium copper) because it closed back above the ‘even money’ level. The liquidation parameter was triggered today, so the position would have been exited at today’s close of -$8,690, resulting in a loss of -$8,715 per spread.

The meltdown in the copper(x2)/gold spread was triggered by the big break in the Chinese stock market this week. Unless you’ve been living under a rock (or an abandoned copper mine), you know that the bear market in commodities has been driven by the slowdown in Chinese demand. They are some of the biggest consumers in the world.

Testing Historic Lows

This week’s breakdown took the copper(x2)/gold spread just below important price support on the nearest-futures chart at -$8,730 (premium gold). This is serious business. Failure to reverse from here and trigger a Wash & Rinse buy signal could smash the spread into the all-time low from 2009 at -$29,380 (premium gold).

To get any relief, the March-February copper(x2)/gold spread needs to find its footing back above the January 2015 multi-year low of -$5,810. Once it does that, it has a chance to make its way back up to technical resistance between the declining 100-day Moving Average (currently around +$1,060) and the December 30th rally high of +$1,345.

March-Feb Copper (x2) Gold spread daily with 100-day MA

March-Feb Copper (x2) Gold spread daily with 100-day MA

Remember that the rallies into the September and November highs peaked just below the 100-day MA. A two-day close above the 100-day MA for the first time since mid-June would indicate that resistance is broken and the bear market may be over.

Furthermore, the December 30th rally high of +$1,345 was the high for last month. A breakout above last month’s high would alter the bearish price structure on this spread and increase the probabilities of a trend change.

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 makes a two-day close above the 100-day MA or a one-day close above the December 30th rally high of +$1,345. Initially, the spread should be liquidated on a two-consecutive day close $500 below the contract low that precedes the entry.

Platinum/Gold Spread: Investment ‘Add-On’ Update

Murphy’s Law Rules

The IMC blog is holding an investment position in the April the platinum/gold spread from the equivalent of -$199.90 (premium gold). We doubled the size of the investment on December 29th at a price of -$176.50. This was done because the spread triggered a bullish trend change by making a two-day close above the declining 75-day Moving Average for the first time since the summer of 2014.

The ‘add-on’ position was to be risked to a two-day close back below the declining 75-day MA. That happened yesterday when the spread closed at -$230.90, resulting in a loss of -$5,440 per spread. Since this investment was initially being backed by $113k, it brings the value down to $107,560 and puts the breakeven level at -$145.50 (premium gold).

As fate would have it, yesterday’s exit occurred when the spread was less than a buck and a half away from the contract low. Perhaps this was the low. This is a good time to remind ourselves that it’s better to be out and wishing we were in, than to be in and wishing we were out.

Reload with New Parameters

So the breakout above the 75-day MA sucker-punched us. Therefore, we are going to slow the moving averages down even more for reentry parameters on the investment ‘add-on’ position.

The platinum/gold spread poked it’s head just above the declining 100-day MA on the last trading day of the year and immediately turned over, indicating that this is working as technical resistance. Therefore, we are now going to use a two-day close above the 100-day MA for the new trend change signal. This has not occurred since August of 2014.

Platinum Gold spread (nearest-futures) daily with the 100-day MA

Platinum Gold spread (nearest-futures) daily with the 100-day MA

Also, the December 31st bounce high of -$167.60 marked the high for the month and sets important near-term price resistance. A sustained close above this point would alter the bearish price structure.

Pushing Our Luck

While it is tempting to get right back into the ‘add-on’ position and risk a few dollars below the contract low, we are going to resist. There are two reasons for this. First, we already have a long investment position in place even though the bear market has not yet reversed. Adding to a position that is underwater is known as a Margin Call –I mean, Martingale– strategy that has led many to financial ruin in the futures market. The only reason we are comfortable with the current investment position in the platinum/gold spread is because we have taken the leverage out so we can endure any drawdown.

Secondly, the spread was driven back to the contract lows in response to that little stock market crash that happened over in China. Also, the US market started the year with the worst first week of the year in history. If things break open next week, the spread could drop even more and cause us to incur a bigger loss than we think we’d theoretically have by getting in here and risking just a few dollars more.

The long-term view for the platinum/gold spread is still bullish because of its history. The trick is to survive the outliers that happen before the eventual reversion to the mean. The higher the leverage, the lower the probability of survival. We have to survive before we can thrive.

Investment ‘Add-On’ Reentry Strategy:

For each April platinum/gold spread entered at equivalent of -$199.90 (premium gold), the IMC blog will add another on a two-day close above the declining 100-day MA or a one-day close above the December 31st bounce high of -$167.60. If filled, liquidate the ‘add-on’ position if the spread makes a two-day close below the 100-day MA.

Feeder/Corn Spread: Setup For a Reentry

Still Riding the Bear

The feeder/corn spread topped out at a historic high fifteen months ago. Since then, IMC has been in and out of this spread on the short side as we’ve tried to capitalize on the bear market.

Feeder Corn ratio (nearest-futures) monthly

Feeder Corn ratio (nearest-futures) monthly

The normal ratio between a 50,000 lb. feeder cattle contract and a 5,000 bushel corn contract is somewhere around 3:1. It peaked at a record high of nearly 7.5:1 in Q4 of 2014 and has been stair-stepping its way lower ever since. In nearly half a century of price data, there have been about half a dozen times when the nearest-futures feeder/corn ratio has been at 4.8:1 (nearly five-to-one) or higher. The prior runs to this level have ultimately been followed by a return to 3:1 or lower. Therefore, we continue to look for short sale opportunities as the trend progresses on a south-bound trajectory.

Ready to Roll

After posting a new contract low in mid-December, the feeder/corn ratio made a sharp rebound into year-end. It was due to a combination punch of the rally in livestock, prompted by position-squaring of short positions and cold weather finally arriving in the US, and the corn market falling on its ear as concerns of El Niño fade away while supplies remain abundant. The momentum is continuing here in the first trading week of 2016.

The bearish macro fundamentals remain in place. After the US drought wiped out supplies and sent the cattle market stampeding to record highs, cow herds started to expand again in 2015. This is expected to continue in 2016, while US exports are already at multi-year lows and imports are at multi-year highs.

On the feed side of the spread, corn prices have pretty much been in a trading range over the last year. Large supplies have capped the upside, but demand has materialized several times when the market dipped below $3.50-per-bushel.

This scenario makes us think that this recent price recovery in the spread is merely a bear market rally and, therefore, a selling opportunity.

Consulting the Charts

From a technical perspective, the recent price action indicates that the bounce is now testing resistance levels.

Over the last three years, the best way to make money in the feeder cattle (basis the nearest-futures) was to be long on a long on a close above the 50-day Moving average and short on a close below the 50-day Moving average. This trend reversal signal has been highly accurate.

Feeder Cattle (nearest-futures) daily

Feeder Cattle (nearest-futures) daily

After a bearish trend change signal was triggered last June, the 50-day MA has provided resistance for feeders. The 21.65 cent bounce off the October low ended after the market tagged the 50-day MA. A decline to new bear market lows followed. Currently, feeders have rallied a little over 26 cents off the December low and they are pushing on the 50-day MA. A reversal from here would be a low-risk selling opportunity. However, a two-day close above the 50-day MA for the first time since June would trigger a bullish trend change signal. This should not be ignored. We’ll let the market tell us if we should get short or not.

April Feeder Cattle weekly

April Feeder Cattle weekly

April feeders have made higher weekly highs for three consecutive weeks and it is now approaching the Fibonacci .618 retracement of the leg down from the October bounce. If the contract does not trade to 158.45 or lower by Friday, this will also be the third consecutive week with higher weekly lows. This is turning into bullish price structure. However, a break below a prior week’s low would negate that and indicate that the bear market in feeders is continuing. A break below a prior week’s low might be a good short sale signal. It certainly worked out that way after the rally crested in October.

The nearest-futures corn contract dropped to a four-month low of $3.50 1/4 to kick off the New Year. This puts it within striking distance of price support in the $3.40s. The market bottomed in this area in May, June, August, and September of 2015, so it represents the bottom of a trading range.

Corn (nearest-futures) daily

Corn (nearest-futures) daily

The catch is that we’re watching the May futures contract for the trade. May corn has made new contract lows in three of the last four weeks as it bleeds off the carry-charge. It may also make lower weekly highs for the fourth-consecutive week. This is bearish price structure. Therefore, it might take a breakout above a prior week’s high to indicate that corn is ready to pop again.

Spread Behavior

Now that we’ve taken a peek at the feeder market and the corn market, the next logical step is to examine the price action of the spread and the ratio.

April-May Feeder Corn (x5) spread daily

April-May Feeder Corn (x5) spread daily

The April-May feeder/corn (x5) spread traded just past the October peak this morning. So far, the spread has rallied a little more than $16,000 off the contract low. This was noticeably more than the $11,487.50 rally from the early October low, but not quite as much as the $18,437.50 rally off the mid-July low. Based on the size of the current rally and the price level, we can probably say that the spread has reached a resistance area. If it rolls over from here, especially after testing resistance at the prior bounce high, a short sale makes sense. If it does not roll over, the spread may advance toward psychological resistance at the ‘even money’ mark next.

April-May Feeder Corn ratio daily

April-May Feeder Corn ratio daily

The April-May feeder/corn ratio reached a two-month high of 4.61:1, putting it just below the October peak at 4.65:1. The bounce is about the same size as the bounce from the mid-July low. This is an ideal place for a reversal. Conversely, a sustained close above 4.65:1 could clear the way for a stampede toward the August high of 5.12:1. Our thoughts remain consistent: Short the spread if it starts to roll over, stay patiently on the sidelines if it does not. Once we get back in, we’ll be looking for setups to add to the position.

Trade Strategy:

The blog will work a hypothetical order to sell one 50,000 lb. April feeder cattle contract and simultaneously buy five 5,000 bushel May corn contracts if April feeder cattle trades .15 below a prior week’s low. 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 -$7,137.50).