Bund/BOBL spread: Stalking a Short Sale at Record Highs

Whiplash

The IMC blog initiated a short position in the December Bund/BOBL spread at 32.12 on September 9th.  It then only took two weeks for the spread to reverse from a two-month low of 31.89 to a new contract high.  This was quite a reversal on the daily timeframe.  Consequently, the position was exited with a loss at 33.90 on September 28th.

The spread also did an about-face on the weekly charts.  The first week of September was marked by a close below the rising 30-bar Moving Average for the first time in a year.  The prior two times this happened, the Bund/BOBL spread continued to decline for months following.

As it turns out, the third time was not the charm for the Bund/BOBL spread.

Time to Reload

Despite the trade loss, traders should be looking to reload their guns and setup for another shot.  On the weekly timeframe, the Bund/BOBL spread is merely returning to where it previously peaked at an all-time high in late July.  A break back below the September low would put the spread back in a bearish position as it would both be below the weekly 30-bar MA again and triggering a Turtle-style (Donchian band) breakout to the downside.

euro-bund-euro-bobl-spread-30-bar-ma-weekly

Euro Bund Euro BOBL spread (30-bar MA) weekly

Furthermore, a break of the September low after the recent breakout to new highs could accelerate a downward move as anyone who went long on this breakout would likely get their liquidation parameters triggered.  We want to be short if that happens.

Trade Strategy:

The blog will work a hypothetical order to short the December Bund/BOBL spread on a close below the September low of 31.89.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 33.90). 

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Cattle/Hog Spread: About Ready To Roll?

Welcome To the Meat Market

Historically, the cattle market and the hog market show a strong correlation in price trends.  Not all the time, but enough to see an obvious relationship.  This makes the relationship between the two meat markets a good candidate for spread trading.

live-cattle-lean-hog-overlay-weekly

live cattle lean hog overlay weekly

The fact that there are some periods where the correlation weakens is actually a good thing.  Trend followers can exploit the correlation breakdown and profit from the outliers, while knowledgeable spread traders can use such instances as an opportunity to start strategizing and getting themselves positioned for an eventual reversion to the mean.

Since peaking out in late 2014, the cattle and hog markets have pretty much trended in the same direction.  The correlation is very high.  Since there appears to be no divergence between the two markets right now, the question a trader might ask would be “Is there any worthwhile trading opportunity in the cattle/hog spread right now?

The Ratio Says…

Looking at the last few decades of price history, it appears that the price of beef is too expensive once it costs at least double the price of pork.  Note the weekly nearest-futures closing price of the cattle/hog ratio and you only see about half a dozen instances where the ratio ran to 2:1 or higher.

live-cattle-lean-hog-ratio-nearest-futures-weekly

live cattle lean hog ratio (nearest-futures) weekly

Furthermore, we also see that once the ratio surpasses 2:1 (where the price of cattle is more the double the price of hogs) it’s only a matter of time until the trend makes a major reversal and the ratio collapses.  Usually it was only a matter of weeks until the top was established after surpassing 2:1.

As it turns out, the ratio between the February live cattle contract and February lean hog contract surpassed 2:1 just last week.  More intriguing is the fact that the current ratio rally high of 2.05:1 is just slightly above price resistance at the October 29th high of 2.02:1.

february-live-cattle-lean-hog-ratio-daily

February Live Cattle Lean Hog ratio daily

If the ratio rolls over right here after clipping the October 2015 high, then it will trigger a Wash & Rinse sell signal for the February cattle/hog spread.  This is a failed breakout pattern, which can lead to a sizable price reversal.

Since the ratio just reached 2:1, the blog will initially short one cattle contract and buy two hog contracts on a close back under 2:1.  This will give us a more dollar neutral position.

february-live-cattle-lean-hog-x2-spread-daily

February Live Cattle Lean Hog (x2) spread daily

If the ratio makes a new high after getting short, the position will be covered for a loss and new setup parameters will be issued.  Most likely, reentering on a break to new correction lows would be the trigger point.  At the same time, we will be cheering the spread on for a run to much higher levels in hopes that we see a new setup materialize at much higher (read unsustainable) price levels.

Trade Strategy:

The blog will work a hypothetical order to sell one 50,000 lb. February live cattle contract and simultaneously buy two 50,000 lb. February lean hog contracts if the February cattle/hog ratio closes below 2:1.  Initially, the spread will be liquidated if the ratio makes a two-consecutive day close above the multi-month rally high that precedes the entry (currently at 2.05:1).

December 2017 Copper/Gold Scale: Just Bagged a Winner!

Sell Side Action…Finally!

The IMC blog pitched a crazy idea this summer about using a scale trading method to take advantage of price fluctuations in commodity spreads that are at extreme levels.  The gist of it is that one would continue buying spreads in intervals as prices declined and then sell those same spreads in intervals on price rebounds.

To keep things interesting and show you how it works, the blog is running a scale in the December 2017 copper(x2)/gold spread.  We are trading a $5k interval ladder where we will buy every $5k down and sell each position for a profit every $5k up.  Also, we are doing this on a closing-basis.

Since our scale started at -$5,000 (premium gold) and the spread was trading at -$21,135 when we launched it on July 20th, we entered four spread positions and considered them ‘bonus fills’ for the -$5k, -$10k, -$15k, and -$20k intervals.  They are for sale on closes above -$15k, -$10k, -$5k, and even money, respectively.

Another December 2017 copper(x2)/gold spread was purchased at -$25,725 on August 1st.  We are selling this one on a close at -$20k or higher.  So far, no action.

On September 6th the blog entered another December 2017 copper(x2)/gold spread at -$30,915, based on the close below -$30k criteria.  As per the plan, we offered it for sale on a close above -$25k.

Well, guess what happened?!  This last purchase was liquidated on September 15th at -$24,115!  That bags a profit of $6,800 on this position.

december-2017-copper-x2-gold-spread-daily

December 2017 copper (x2) gold spread daily

One of two things will happen next: The spread will continue to rally and close above -$20k and allow us to sell the position we bought at -$25,725, or else the spread will close back below -$30k and we will reenter the position that we just sold.

It will be interesting to see how everything plays out between now and November of 2017 when we finally have to think about rollovers.  Until then, let’s hope for some volatility to keep the December 2017 copper(x2)/gold spread banging around like a pinball and racking up the points!

Minneapolis/Chicago Wheat Spread: Time For a Turn?

Seeds of an Opportunity

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.

minneapolis-wheat-chicago-wheat-overlay-weekly

Minneapolis wheat Chicago wheat overlay weekly

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.

Getting Pricey

In mid-August the nearest-futures Minneapolis wheat contract closed at a premium of more than $1-per-bushel to the Chicago (CBOT) wheat contract.  That doesn’t happen very often.  Historically, it appears to be ‘expensive’ whenever the Minneapolis wheat contract is at a premium of 70 cents over the CBOT wheat contract.

The problem with these old guidelines is that the spread has been substantially higher than 70 cents on a few occasions over the last several years.  The Minneapolis/Chicago wheat spread made it to nearly two and a half dollars at the end of 2011 before finally rolling over.  And the barn-buster, never-seen-before, all-time record high was made in 2008 when the spread finally put a flag on the moon and peaked at $8.53 (!) before crashing back to earth.

minneapolis-wheat-chicago-wheat-spread-weekly

Minneapolis wheat Chicago wheat spread weekly

The interesting thing, however, is that the bear markets that followed in this spread all had the same outcome.  Each time the Minneapolis wheat price reached a huge premium over Chicago wheat and finally ended the run, the reversal lasted until the price premium finally went to the Chicago wheat.  Even the outlier bull markets of 2008 and 2011 couldn’t escape this repetition of history.  Perhaps Mark Twain was correct when he said, “History doesn’t repeat, but it does rhyme.”

So the question is: Do we start looking for a reversal setup because the Minneapolis/CBOT wheat spread has surpassed the old watermark level of 70 cents…or do we wait for it to get somewhere in the vicinity of the 2011 level before stalking it?

The Ratio Filter

As readers of this blog already know, we like to use a ratio to filter what we see in the price spreads.  This is done to normalize false readings of outliers that appear on a spread chart when the prices of the underlying markets are themselves at record extremes.  Sometimes, the ratio can even be a tie breaker when deciding which spread to pursue as the trade opportunity with the highest probability of success.

Normally, the Minneapolis 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.

minneapolis-wheat-chicago-wheat-ratio-weekly

Minneapolis wheat Chicago wheat ratio weekly

Our antennas go up when the Minneapolis wheat exceeds a premium of 25% over the CBOT wheat.  This has happened about half a dozen times in the last four decades.  It never lasted.  As a matter of fact, the inevitable reversal that finally followed a reading above 1.25:1 drove the Minneapolis wheat all the way down to where it was priced at a discount to the CBOT wheat.  This certainly indicates that a premium of 25% or more makes the Minneapolis/Chicago wheat spread a short sale candidate.

Last month the nearest-futures Minneapolis wheat/CBOT wheat ratio surpassed 1.25:1.  Therefore, the ratio confirms what we already suspected with the spread: A short sale opportunity is shaping up here.

Dialing It In

Take a look at the December Minneapolis wheat/CBOT wheat spread.  Although it’s been in an uptrend since the start of 2016, the price action of the last few weeks could indicate that the trend is changing.

First of all, the spread peaked at +82 1/4 cents on July 5th and had a normal correction.  This price peak was briefly exceeded on August 22nd when the spread reached +84 1/2 cents and then quickly pulled back.  This appeared to be a Wash & Rinse (failed breakout) sell signal.

Then it gets even more interesting.  The December Minneapolis wheat/CBOT wheat spread made a new contract high of 89 cents on August 30th and then rolled over again the very next day.  This one-day high close was enough to disqualify the first failed breakout attempt, only to turn into a second failed breakout attempt.  It sure looks like the spread is having a hard time sticking at these levels.

december-minneapolis-wheat-chicago-wheat-spread-daily

December Minneapolis wheat Chicago wheat spread daily

Now direct your attention to the rising 75-day Moving Average.  The spread has closed above the 75-day MA every single day for over six months straight.  However, the spread has been on the defensive for the last three weeks and is now less than two cents away from support at the 75-day MA.  Initially, a close below the 75-day MA for the first time since the first half of March and a break of the August 25th reaction low could be the technical catalyst that confirms the end of the bull run.  If so, the short side of the December Minneapolis wheat/CBOT wheat spread seems like a good place to be positioned.

Trade Strategy:

The blog is working a hypothetical order to sell one December Minneapolis wheat contract and simultaneously buy one December Chicago wheat contract on a close below the rising 75-day MA (currently at +71 cents).  If filled, risk a two-day close of three cents above the contract high that precedes the entry (currently at +89 cents). 

Platinum/Gold Spread: Two Records Broken In 2016

Breaking Records

A year ago, the blog entered an unleveraged position in the platinum/gold spread at the equivalent of -$201.20 (premium gold).  Back in April, leverage was applied as an ‘add-on’ investment position was initiated.  This position was then exited with a loss two months later, putting us back in the unleveraged position with a big, fat cash cushion.

This year the platinum/gold spread made two new records for the history books.

The first new record set in 2016 was the price low.  The nearest-futures platinum/gold spread posted a new all-time low when it closed at -$343.30 (premium gold) on June 27th.  That same day, the ratio between the nearest-futures platinum and gold spread matched the thirty-three year low of 0.74:1 that was posted on January 20th.

platinum-gold-spread-nearest-futures-weekly

Platinum Gold spread nearest-futures weekly

The second new record set in 2016 was the duration of the price inversion between platinum and gold.  The nearest-futures platinum price closed lower than the nearest-futures gold price on January 15, 2015 and it has closed at a discount every day since.  This duration of one year and eight months just beat out the prior record inversion streak of one year and seven months that occurred from September 1981 and April 1983.

Staying the Course

Although the “investment” strategy for the platinum/gold spread has been underwater for the last several months, the thesis has not changed.  Therefore, it makes sense to keep holding patiently and once again look for a setup to add some leverage after a trend change occurs.

You may have read the book The Big Short by Michael Lewis.  Maybe you even caught the movie version.  One of the takeaways –at least, from this traders’ perspective- is that you can be right on an idea and still hemorrhage money before your idea is proven correct.  Recall that the subprime short sellers in the book/film were losing millions of dollars for a couple of years before the inevitable collapse took place.  So you have to develop a strategy on how to stay solvent while waiting for the inevitable turn.

This is the whole reason that the “investment” strategy holds a low or non-leveraged position, adds a little bit of leverage if the trend starts to turn, and then cuts back on the leverage if the trend moves adversely again.  We are more concerned with how to keep the position afloat until the payoff, rather than trying to be greedy pigs and make the most money possible.  The time to start playing offense is after our defense has done its job of capital preservation and the capital gains finally start to materialize.

Investment Strategy:

For tracking purposes, the blog will liquidate the long October-December platinum/gold spread investment position and simultaneously enter a long investment position in the January-February platinum/gold spread at the market-on-close on Tuesday, September 20th.  There are currently no liquidation parameters for this low-leverage position.  Factoring in the results of one ‘add-on’ investment position, the bankroll for this spread is currently $101,920.

Cocoa/Sugar Spread: Lots of Downside Still Ahead

Positioned In 2017

The IMC blog continues to ride the bear market in the cocoa/sugar (x2) spread.  The blog was holding a short position in the September-October cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$1,834.40 (premium cocoa), a second ‘add-on’ position that was entered at the equivalent of -$1,521.80 (premium sugar) on February 18th, and a third ‘add-on’ position that was entered at the equivalent of -$4,731.20 (premium sugar) on April 19th.

Due to the Last Trade Day for the September cocoa contract, we rolled both the cocoa and the sugar to the March 2017 contracts at the close of September 13th.  The March spread is trading $1,797.20 lower than the September-October spread, so we’re now short the spreads from the equivalent of +$37.20 (premium cocoa), -$3,319 (premium sugar), and -$6,528.40 (premium sugar).

Still Strapped In

In prior posts, we mentioned that our minimum downside target the cocoa/sugar (x2) spread is -$20,000 (premium sugar), basis the nearest-futures.  Well, we’re nearly there and the March 2017 spread has already hit -$19,340.40 (premium sugar).

cocoa-sugar-x2-spread-weekly

Cocoa Sugar (x2) spread weekly

So what now?

We are going to maintain our short position.  The reason is two-fold.  First of all, the trend is still down.  Over the last several months, the March 2017 cocoa/sugar (x2) spread has made three different bear market bounces that peaked just above the declining 50-day Moving Average.  The spread then rolled over and made new bear market lows just a few weeks or even days later.  So until the spread is consistently above the 50-day MA, the bear market remains firmly intact.

march-cocoa-sugar-x2-spread-daily

March Cocoa Sugar (x2) spread daily

The second reason to stay short is because of the history of the ratio between cocoa and sugar.  Historically, whenever the ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract has reached 2.5:1 or higher it has ultimately reversed and entered a multi-year bear market.  The ratio peaked at a thirteen-year high of nearly 2.7:1 one year ago this week.  Therefore, we may only be in the middle or even early stages of the current bear market.

Furthermore, prior bull markets that peaked at 2.5:1 or higher have been followed by substantial bear markets that pushed the ratio below 0.8:1 each time.  Think of it this way: whenever a cocoa contract has been worth at least two and a half times the value of a sugar contract, the bear market that followed pushed the sugar contract value to a premium of 35% or more over the cocoa contract.

cocoa-sugar-x2-ratio-weekly

Cocoa Sugar ratio weekly

Although sugar has been outperforming cocoa over the last few months, it still has yet to reach an equal value to the cocoa contract.  Therefore, history suggests that the smart macro bet is to stay positioned on the short side of the cocoa/sugar (x2) spread until in the value of a sugar contract is greater than the value of a cocoa contract.

We like smart macro bets!  Therefore, as long as the trend remains bearish, we’ll stay the course.

Aussie/Kiwi Spread: Returning to the Historic Low?!

Still Down Under

The IMC blog entered a long position in the September Australian dollar/New Zealand dollar spread at 4.31 cents (premium Aussie) on July 14th and exited at 2.11 cents (premium Aussie) on September 12th.  The break to new contract lows triggered the liquidation order.

This morning the Aussie dollar has a premium of less than two cents over the Kiwi dollar and the ratio hit 1.03:1.  There is currently nothing to stop this spread from returning to the April 2015 historic low of 0.61 cents.  Who knows, maybe the it’s on the way to ‘even money’ or even to where the Kiwi finally has the premium!

aussie-kiwi-spread-nearest-futures-daily

Aussie Kiwi spread (nearest-futures) daily

At some point, however, this trend will end.  We want to participate in the upswing when it happens.

Right now, there are two price points of interest on the charts.  The first is one we already mentioned: the April 2015 historic low of 0.61 cents.  If the spread gets here, we will be watching it very close to see what transpires.

The second point of interest is the July low of 2.67 cents on the December chart.  This was an important support level.  Now that it has been broken, it has turned into an important resistance level.  A close back above this price would indicate that a recovery is at hand and a close above the current September high of 2.86 would make the odds even more favorable.

december-aussie-kiwi-spread-daily

December Aussie $ Kiwi $ spread daily

I love Peter Brandt’s analogy for this “support turned resistance” idea.  He calls it the ice line.  Brandt says that the price low is like the ice on a frozen lake.  It supports you as you walk out on it to go ice fishing, skating, etc.  It should hold.  But if the ice cracks and you fall through, you are now underwater.  That ice line has suddenly turned into an overhead resistance barrier!  You need to get your head back above the ice and crawl out of the water if you want to survive.  For all you fellow Floridians who can’t relate to this idea on a personal level, go watch Fargo and you’ll get an idea of what I’m talking about.

For now, the blog will look to reestablish a long position in the Aussie/Kiwi spread if it can crawl it’s way out of the water.

Trade Strategy:

For tracking purposes, the IMC blog will make a hypothetical trade by buying one December Australian dollar contract and simultaneously selling one December New Zealand dollar contract if the spread closes above 2.86 cents (premium Aussie).  If filled, the spread will initially be liquidated on a two-consecutive day close .25 cents below the contract low that precedes the entry. 

Feeder/Corn Spread: Back In a Bearish Bet

Headed South For the Winter

On September 6th, the IMC blog entered a short position in the Nov-Dec feeder/corn (x4) spread.  We sold a November feeder contract short at 126.075 (contract value of $63,037.50) and bought four December corn contracts at $3.28 1/2 (a sum contract value of $65,700), which puts us in the position at a price of -$2,662.50 (premium corn).

Initially, we are going to risk the trade to a two-day close above +$5,500 (premium feeders).  That’s nearly $500 above the August 30th contract high.

Bearish Technical Outlook

First of all, a double top pattern was formed between the August 9th high of +$4,962.50 and the August 30th high of $5,012.50.  Yesterday’s close below the August 19th low of +$237.50, which is the lowest point between the two highs, confirmed the pattern.

Secondly, the spread closed below the rising 50-day Moving Average for the first time since mid-June.

nov-dec-feeder-corn-x4-spread-daily

Nov-Dec Feeder Corn (x4) spread daily

Next, the nearest-futures spread closed above the widely-watched 200-day Moving Average at the start of August for the first time in a year.  This was a bullish event.  But here at the start of September, the nearest-futures spread closed back under the 200-day MA.  This could indicate that the party is over.

The spread should now be on its return trip to the mid-June low of -$23,650 (premium corn).  Based on history, a clean and sustained break of this low should clear the path for a descent to the -$40k area.  You can be that we’ll be watching for pyramiding opportunities if the bear market persists.

Loon/Kiwi Spread: What Will Break the Bearish Pattern?

Trade Exit

On July 29th the IMC blog initiated a long position in the Canadian dollar/New Zealand dollar spread at 4.75 cents (premium Canada).  The position was liquidated at 3.57 cents on September 1st.  This resulted in a loss of $1,180 per spread.

Canadian $ Kiwi $ spread (nearest-futures) daily

Canadian $ Kiwi $ spread (nearest-futures) daily

Despite the hit, we are ready to jump right back in on a recovery signal.  After all, the loon/kiwi spread has been historically undervalued for the last few months.  And over the last few years, dips below the 4-cent level have been followed by rallies of several hundred basis points.

The New Parameters

The December Canadian dollar/New Zealand dollar spread made an important price peak at 11.46 cents back in April.  Since then, the spread has not cleared a prior month’s high.

Furthermore, the spread has now made lower lows for four consecutive months.  The August and September lows were even new contract lows.

December Canadian $ Kiwi $ spread daily

December Canadian $ Kiwi $ spread daily

This pattern of lower highs and lower lows is bearish.  To alter the price structure and indicate that the downtrend may have come to an end the spread needs to clear a prior month’s high.  Therefore, the blog will use a close above the August high as a trigger to reenter a long position this month.  If that doesn’t happen by September 30th we will lower the entry price level.

More confirmation

Let’s continue to keep an eye on the 75-day Moving Average as well.  When the Canadian dollar/New Zealand dollar spread made closes above the 75-day MA in May 2014, April of 2015, and March of 2016 there was follow-thru of several hundred more basis points.  So a close above the 75-day MA for the first time since just before Memorial Day weekend could be a good confirmation that a new run higher is in full swing.

Trade Strategy:

Place a hypothetical order to buy one December Canadian dollar contract and simultaneously sell one December New Zealand dollar contract if the spread closes above the August high of 5.78 cents (premium Canada).  If filled, the spread will initially be liquidated on a two-consecutive day close 25-basis points below the contract low that precedes the entry.