Gold/Crude Spread: Bear Market Rally…Or Resumption of the Bull Market?

Bumped Out

The IMC blog initiated a hypothetical short position in the December gold/crude (x3) spread on June 24th at -$15,000 (premium crude).  The position was liquidated at -$7,280 (premium crude).  This represents a loss of $7,720 on the trade.

The initial foray into this spread resulted in a loss.  However, we will not let that stop us from going back in if it does start to rollover from here.  Recall that prior runs to similar levels resulted in huge bear market declines.

If the top really was established back in February when the nearest-futures spread reached an all-time high, then a return to price support at last summer’s low of -$61,960 (premium crude) is not an unreasonable expectation.  Furthermore, if the gold/crude ratio drops to 14:1 or lower like it has done in the past, it would put the gold/crude (x3) spread somewhere between -$78,000 and -$148,000 (premium crude).  This long-term expectation helps take the sting out of the short-term trade losses that we just experienced during the trend transition.

What Say the Charts?

From a technical perspective, the spread turned bullish as it made a two-day close above the 100-day Moving Average for the first time since mid-April and it cleared price resistance at the May high (this is what our exit criteria was based on).  To return to a bearish posture, it needs to close back under the 100-day MA.

December Gold Crude Oil (x3) spread daily

December Gold Crude Oil (x3) spread daily

The big question is whether the April/June excursion below the 100-day MA was a bull market correction just like we saw in April/June of 2015…or if it was the start of the bear market?  After all, when the spread closed back above the 100-day MA in July of last year it stayed above it for the remainder of the year and continued to push its way to new record highs.

A close back below the 100-day MA would put the spread back on the defensive and raise the odds that this was a bear market rally.  A break of the early June correction low would confirm it.

So far, the rally has recovered a little more than half of the entire decline from the February 11th high of +$14,850 (premium gold) to the June 8th multi-month low of -$32,950 (premium crude).  If it can make it to -$3,410 (premium crude) on a closing-basis, the spread would reach the Fibonacci .618 retracement of the decline.  From a technical perspective, this would be an ideal place for a secondary (lower) top to form.  Still, we’d want to see the spread back under the 100-day MA to feel more confident of getting back on the short side again.  So that’s how we’re gonna play it.

Trade Reentry Strategy:

The blog will make a hypothetical trade by selling one 100 oz. December gold contract and simultaneously buying three December 1,000 barrel crude oil contracts if the spread closes below the 100-day Moving Average (currently around -$12,720).  If filled, exit on a two-consecutive day close $500 above the highest closing price after July 6th.

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