Meal/Bean Spread: Ripe For a Bear Market

Another Soy Play

Yesterday we posted an article on the spread between soy meal and bean oil.  Today we also want to point out an opportunity in the spread between meal and soybeans.  Remember, meal is a direct derivative of the beans, much like gasoline is a direct derivative of crude oil.  So a strong price correlation between the two should come as no surprise.

Soybeans Soy Meal overlay weekly

Soybeans Soy Meal overlay weekly

Take a glance at the last forty-five years of weekly closing prices of soy meal and soybeans.  The charts show an undeniable link between the price action and trends of these two markets.

The Bean/Meal Ratio

On the weekly nearest-futures chart, the ratio between the value of one 5,000 bushel soybean contract and the value of one 100-ton soy meal futures contract recently sank to a one and a half year low of 1.35:1.  Historically, the ratio has only dropped below 1.4:1 about half a dozen times in the last forty-five years.  Therefore, it’s worth paying attention to.

Soybeans Soy Meal ratio weekly

Soybeans Soy Meal ratio weekly

Prior drops below 1.4:1 have been followed by multi-month and even multi-year rallies.  So the recent drop below 1.4:1 tells us that the stage for a major rally is being set.  Using this precedent, it makes sense to start watching for trend change signals to time the turnaround.

Spread It Out

We’re going to take a look at spread between the value of the sum of two soy meal contracts and one soybean contract.

At the June 10th high, two December soy meal contracts were valued at a premium of +$23,722.50 over the value of one November soybean contract.  Historically, the spread has been a great short sale candidate whenever the meal reached a premium of +$20k or more over the beans.

Soy Meal Soybean (x2) spread weekly

Soy Meal Soybean (x2) spread weekly

Prior tops at +$20k or higher (premium meal) were followed by drops back under +$9k (premium meal).  Tops above +$20k (premium meal) prior to the 2012 drought were even followed by bear markets that took the spread back to ‘even money’ or lower.  In light of this, a spread trader should be watching for a place to short the soy meal (x2)/soybean spread when it rolls over.

Trend Change Signal

After establishing the contract low in early April, the Dec-Nov soy meal (x2)/soybean spread has rocketed higher.  It posted new contract highs just six weeks after the contract low and continued to run several thousand dollars more.

Dec-Nov Soy Meal Soybean (x2) spread daily

Dec-Nov Soy Meal Soybean (x2) spread daily

All good things come to an end.  Since the spread has closed above the rising 30-day Moving Average every single day for more than two months straight, a close back below the 30-day MA could indicate that the end has arrived.  If so, the blog will take a crack at the short side of the soy meal (x2)/soybean spread.

Trade Strategy:

The blog will work a hypothetical order to sell two 100-ton December soy meal contracts and simultaneously buy one 5,000 bushel November soybean contract if the spread closes below the rising 30-day MA (currently around +$21,725).  If filled, exit on a two-day close $500 above the contract high that precedes the entry.

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