Soy Meal/Bean Oil Spread: Time to Cover the Shorts

Ready To Pull the Trigger

Back in the late spring, the ratio between the value of one 100-ton soy meal futures contract and the value of one 60,000 lb. bean oil contract reached 2:1.  Since the ratio has only been at 2:1 or higher a handful of times in the last forty-five years, we knew that a short sale opportunity was in the making.

We initiated a short position on July 7th in the soy meal/bean oil (x2) spread when the spread closed below the rising 30-day Moving Average for the first time in three months, triggering a bearish trend change signal.

Due to the rapid descent, we were able to quickly pyramid the positions by adding spreads four more times.

Initially, we started the position in the September futures contracts.  Then we rolled to the current December contracts.  Taking into account the carry charge, the short December soy meal/bean oil (x2) spread positions were entered at the equivalent of -$432 (premium bean oil), the equivalent of -$4,318, the equivalent of -$6,824, the equivalent of -$8,900, and -$11,196.

The average entry price on the five short sale price points is -$6,334.

The Soy Meal Market

December soy meal appears to have started a move higher today.  There are three technical signals for this.

First, it rocketed to the highest price in over two months.  This is a Turtle-style or Donchian Band breakout signal that could attract classic trend followers.

Second, the market is set to make a two-day close above the declining 50-day MA for the first time since the first half of July.  This would be a bullish trend change signal.  The last time this occurred was in mid-March and trading it would have put you long right before the huge run into June occurred.

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December Soy Meal daily

Third, December soy meal is poised to close well-above the 200-day MA for the first time since late August.  Many macro traders use the 200-day MA to determine a market’s trend.

This is all backed up by the seasonal pattern that shows that meal usually establishes a major bottom in October.  Looks like it’s right on time this year!

The Bean Oil Market

While meal is just starting to turn bullish, the bean oil market has been in an uptrend for quite some time.  First, it bottomed in late July.  Then in early August, it made a two-day close above the declining 50-day MA for the first time in nearly three and a half months.  The market did close back under the 50-day MA in mid-September, but it turned around two days later and the uptrend resumed.

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December Bean Oil daily

This week the market ran into a potential problem.  On Monday the December bean oil cleared price resistance at the April 21st contract high of 35.81.  But after a one-day close above this high, the contract dipped back under it and sank to a four-day low today.  This failed breakout attempt triggered a Wash & Rinse sell signal.

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Bean Oil (nearest-futures) weekly

Furthermore, bean oil hit major technical headwinds on the weekly timeframe.  The market entered a resistance zone between the 2015 nearest-futures high of 35.29 and the 2010 nearest-futures low of 35.75 (old price support, once it has been broken, become new price resistance).  It is also nearing the declining weekly 200-bar MA at 36.51.  A close back under the 2015 high of 35.29 and the April 2016 nearest-futures high of 35.14 would trigger a Wash & Rinse sell signal on the weekly timeframe as well.

The Spread Situation

With soy meal just starting a potential run to the upside…

And bean oil potentially topping…

The soy meal/bean oil (x2) spread is vulnerable to a sizable reversal to the upside.

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December 2016 Soy Meal Bean Oil (x2) spread daily

Recall that we set the intervals for the ‘add-on’ entry and exit levels at $2k.  This was based on the spreads volatility.  Currently, the December spread has rallied as much as $2,746 off Monday’s low.  This ‘overbalancing of price’ could be an indication that the trend in the spread is changing.

A two-day close above the declining 30-day MA for the first time since the first week of July would confirm it.  In light of this, we want to go ahead and exit stage right!

Trade Strategy:

On the five short December soy meal/bean oil (x2) spreads entered at the equivalent of -$432 (premium bean oil), the equivalent of -$4,318, the equivalent of -$6,824, the equivalent of -$8,900, and -$11,196, exit at -$9,712 or better.

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Soy Meal/Soybean Spread: Book the Profits!

All Good Things…

Must come to an end!  This includes profitable market trends as well.

The IMC blog stalked the Dec-Nov soy meal (x2)/soybean spread for a short sale setup last summer after it reached historically unsustainable highs.  The short sale campaign was finally initiated in late June when the spread closed below the rising 30-day Moving Average for the first time in two and a half months.

As the downtrend unfolded, the position was pyramided a couple of more times when we sold more spreads short at the start of August and even more at the end of August.

This put us in an initial short position at +$21,125 (premium meal), a second ‘add-on’ position at +$17,690, and a third and final ‘add-on’ position at +$14,202.50.  The average entry price point for the three short sales is +$17,672.50.

This Week’s Price Action

The Dec-Nov soy meal (x2)/soybean spread has exploded higher in the last couple of days.  Intraday, the spread is currently nearing the early September high.

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Dec Nov Soy Meal (x2) Soybean Spread Daily

Furthermore, the spread close back above the 30-day Moving Average yesterday for the first time since July 1st.  It is likely to close above it again today, confirming a bullish trend change signal.

Add this to the seasonal pattern that shows a tendency for meal and beans to both establish major lows in October and you can see that things are now stacking up in favor of the bulls.  To that end, it makes sense to book the profits on this trade.

Trade Strategy:

On the three Dec-Nov soy meal (x2)/soybean spreads entered at +$21,125 (premium meal), +$17,690, and +$14,202.50, exit at +$14,202.50 or better or at the market-on-close, whichever occurs first.

Kansas City/Chicago Wheat Spread: Bag the Profits!

A Change of Trend

The IMC blog is holding a long position in the December Kansas City/Chicago wheat spread that was entered at the equivalent of -12 1/4 cents (premium CBOT wheat) on July 6th.  An ‘add-on’ position was entered at the equivalent of +7 3/4 cents (premium KC wheat) on August 26th.

Initially, we proposed the thesis that Kansas City wheat would not stay at a discounted price to the Chicago wheat.  Once a technical trend change signal occurred, we initiated a long position.  As the move higher confirmed our outlook, another setup occurred that allowed us to add to the position.

Based on the history of the KC/Chicago wheat spread, we expected a minimum return to where the KC wheat would trade at a premium of 35 to 40 cents or more over the Chicago wheat.  That may still be the case.  However, the price action of the last several days indicates that the spread is back on the defensive.

The Magic of Thirteen

The nearest-futures KC/Chicago wheat spread has found an important inflection point around +13 cents (premium KC wheat).  There’s just something about how this Lucky 13 level that has determined the fate of this spread for nearly two years.  It’s almost spooky.  And we’re not pointing it out just because it’s getting close to Halloween, either!

Just take a look at how it has played out and judge it yourself:

After a five and a half month bear market decline of nearly $1.33, the KC/Chicago wheat spread bottomed at +13 1/4 cents in December 2014.  A sizable bounce followed, indicating that the December low was major support.

The spread then retreated again and bottomed out at +13 cents in March of 2015.  This created a potential double bottom on the chart.  This was confirmed as the spread than rocketed 33-cents higher over the next month.

The KC/Chicago wheat spread reversed in April 2015 and bottomed once more at +13 cents in the second half of the month.  The nearly 23-cent rally that unfolded over the next month then created a potential triple bottom on the chart.

The third time was not the charm for this spread!  In the second half of June 2015, the nearest-futures KC/Chicago wheat spread made a two-day close below +13 cents.  This was a major support breach and things unraveled quickly.  The spread inverted before the month was out.

Now that the +13-cent support level had been broken, it became a major resistance level.  This is an important charting principle.

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Kansas City Chicago Wheat spread (nearest-futures) daily

The point was proven when the spread bottomed at an eight-year low of -40 1/4 cents (premium CBOT wheat) in early November 2015 and then started on the road to recovery.  A couple of weeks after the new year started, Kansas City wheat finally closed with a premium over the Chicago wheat for the first time in nearly seven months.  After a correction into early February, the bull run resumed.  This multi-month climb finally stopped on March 16th at a price of…+13 cents (premium KC wheat)!

The mid-March high marked a major turning point.  The nearest-futures KC/Chicago wheat spread was inverted again by early April.  The decline lasted for nearly three and a half months.  By the time it bottomed again at the end of June, the spread was only a nickel away from the multi-year low that it had hit in 2015.

Just like a pendulum, commodity spreads have a tendency to swing from one extreme to the other.  So it’s no surprise that from the depths of the Q2 lows, the KC/Chicago wheat spread turned back up.

A couple of months into the rally and the KC/Chicago wheat spread had made it all the way back up to +13 1/4 cents (premium KC wheat).  This occurred on September 2nd.  The spread closed at +13 cents the next day and then backed off the following day.  It looked like the spread may have once again crested at +13 cents and was ready to start another decline.

Then something interesting happened…

The KC/Chicago wheat spread recovered and made a two-day close above +13 cents on September 8th and 9th.  This hadn’t happened since the summer of 2015.  Now that the +13-cent resistance level had been broken, it once again became a major support level.

Furthermore, this put it above the prior top at the mid-March high.  The bulls were firmly in control now.

However…

This week the December KC/Chicago wheat spread –which is currently the nearest-futures spread-  kicked off the new month and the new quarter with a close back below +13 cents.  With just a few hours of trading left to go for the week, it appears that the spread will have spent the entire week below +13 cents.

By clearing the mid-March high and then dropping back under it, the nearest-futures KC/Chicago wheat spread triggered a Wash & Rinse sell signal.  This is a good reason to bag the profits on the long spread position and get to the sidelines.

Moving Average Confirmation

In addition to the Wash & Rinse sell signal, the December KC/Chicago wheat spread triggered a bearish trend change when it closed below the rising 30-day Moving Average for the first time in several months.

Recall that we initiated the long position in early July when the spread had made a two-day close above the declining 30-day MA for the first time in over three months.

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December Kansas City Chicago Wheat spread daily (30-day MA)

Now that the spread is closing back below the 30-day MA –especially since it will close below the 30-day MA every single day this week- it takes away our reason to be long.  For the last year, the 30-day MA has been a highly-accurate indicator for which side of the December KC/Chicago wheat spread to be positioned on.  Don’t ignore it.

Furthermore, look how things turned out when the spread closed below the 30-day MA six months ago at the end of March.  The sell-off continued for another three months.  If we’re lucky, perhaps we can book some profits here and then get a reentry signal after a sizable decline gives us another setup at much lower levels.

Trade Strategy:

On the December Kansas City/Chicago wheat spread that was entered at the equivalent of -12 1/4 cents (premium CBOT wheat) and the long ‘add-on’ position was entered at the equivalent of +7 3/4 cents (premium KC wheat), exit at +8 1/4 cents or better. 

Cattle/Hog Spread: Waiting For the Next Pitch

One Strike, But We’re Still Swingin’

The IMC blog initiated a hypothetical short position in the February cattle/hog (x2) spread at 0.925 (premium hogs) on October 3rd when the February cattle/hog ratio closes below 2:1.

The spread was liquidated at 7.725 (premium cattle) on October 5th because the ratio made a two-day close at new highs for the move.  This resulted in a loss of -$3,460 on the trade.

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Live Cattle Lean Hog ratio (nearest-futures) daily

The February contract ratio closed at a new contract high of 2.16:1 yesterday.  This places it right on the doorstep of potential technical resistance at 2.21:1, which is the major Fibonacci .618 retracement of the entire nearest-futures decline from the March 2015 all-time high of 2.76:1 to the June 2016 two-year low of 1.32:1.

If the nearest-futures cattle/hog ratio doesn’t peak somewhere around here, a test of the November 2015 secondary high at 2.46:1 is possible.

Regardless of where the ratio finally tops, we do know this: History shows that the ratio has been unsustainable above 2:1.  So despite the loss on this short sale attempt, the IMC blog still favors the short side of the February cattle/hog (x2) spread.  Therefore, we won’t hesitate to get right back into the position if the spread rolls over again.

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February Live Cattle Lean Hog (x2) spread daily

In light of this, the reentry setup we’ll employ is to get short on a break below the October 3rd reaction low where the first short sale attempt occurred.  Once again, we will simply risk to new highs afterwards.

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 spread closes below 0.925 (premium hogs).  Initially, the spread will be liquidated if the ratio makes a two-consecutive day close above the contract high that precedes the entry, which is currently at 7.725 (premium cattle).

Copper(x2)/Gold Spread: Long-Awaited Birth of the Bull?

The Real McCoy?

Just before Memorial Day, the IMC blog bought a December copper(x2)/gold spread.  The position was liquidated with a loss a few weeks later when the spread hit new lows for the move.

Glad we got out.  The spread proceeded to head south.  Just a month after our exit, the nearest-futures copper(x2)/gold spread breached major support at the 2009 all-time low of -$29,380 (premium gold).

However, there was no dramatic waterfall decline triggered by the support break.  The spread bottomed at -$30,085 on July 7th and the reversed higher.  The bottom was established less than $1,000 below the 2009 Financial Crisis low.

However, the July low was finally broken right after Labor Day.  That’s when the copper(x2)/gold spread crashed to…-$30,840.  Huh.  Not very dramatic, was it?  The September low was set in place only $755 below the July low.

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Copper (x2) Gold spread daily (nearest-futures for 10 yrs).jpg

The fact that the spread cracked the Financial Crisis low by a slim margin –twice!– and then quickly turned around indicates that this bear market is scraping the bottom of the barrel.  As a matter of fact, it is a major buy signal.  Readers of this blog may be familiar with what we call this pattern: The Wash & Rinse.  It’s a failed breakout signal that often leads to a major move in the opposite of the initial breakout.  Looks to me like that’s what happened.

Bullish Trend Change

Back in June, the blog set trade parameters in place to take another crack at the long side of the December copper(x2)/gold spread.  Our trigger point was to get in if/when the spread could make a two-day close above resistance at the declining 100-day Moving Average.

Prior rallies had ended either side of the 100-day MA, so a sustained close above the 100-day MA would be our indicator that the switch had been flipped.

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December Copper (x2) Gold spread daily (100-day MA)

Last week, the trend change finally happened.  The spread made a two-day close above the 100-day MA for the first time in over fifteen months.  The fact that it occurred after a Wash & Rinse off of historic lows endorses the idea that a major bottom is in place.

Therefore, the IMC blog entered a long position in the December copper(x2)/gold spread at -$23,100 on September 29th.

Like we said a few months before, we believe that a bullish trend change signal could position us in the buying opportunity of a lifetime before it makes any fundamental sense.  Last week’s action may have just done that.

More Confirmation

Commodity markets are mean-reverting, so trends that reach historic extremes are often followed by sizable trends in the opposite direction.

Not only did the copper(x2)/gold spread reach an all-time low last month, but the ratio between the value of one 25,000 lb. copper contract and one 100 oz. gold contract also bottomed at a multi-year low of 0.386:1.  This was just a stone’s throw from the Financial Crisis low of 0.35:1.

Keep in mind that the copper/gold ratio has only been at 0.35:1 or lower on three occasions in the last four decades.  So this was a rare event to get in the same vicinity.  The fact that the copper/gold ratio also surpassed the 100-day MA for the first time in over fifteen months was more confirmation of a trend change off of historic lows.

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Copper (x2) Gold spread weekly (underwater line)

In addition, the copper(x2)/gold spread is still inverted!  It has been underwater for over nine consecutive months now.  This is the longest inversion since the mid-1980s.

So despite the recent trend change and the run to a three-month high, the copper(x2)/gold spread is still historically underwater.  This leaves a lot of profit potential ahead of us.  You can bet that we will be watching vigilantly for opportunities to add to our long position as the trend unfolds.

December 2017 Copper/Gold Scale: Another Good Exit

Pulling Down Another Winner

The IMC blog is currently running a scale trade campaign on the December 2017 copper(x2)/gold spread.  To review the strategy, read some of the prior posts on the subject.  This post is merely an update on the most recent action.

The first profitable trade in this campaign was bagged on September 15th when a position was liquidated for a profit of +$6,800.

After purchasing a December 2017 copper(x2)/gold spread at -$25,725 on August 1st, we immediately put in liquidation parameters to sell it on a close at -$20k or higher.  This finally happened on October 4th when the spread closed at -$18,695.

The trade secured a profit of +$7,030 this time around.

If the spread closes back below -$25k the blog will simply reenter a long position.

If the spread closes above -$15k the blog will sell one of the four spreads that was purchased at -$21,135 back on July 20th.  That was when we initiated the scale campaign with ‘bonus fills’ for the -$5k, -$10k, -$15k, and -$20k intervals.

Interesting Developments

As scale traders, we don’t care which happens next: a sale or a repurchase.  But as chart technicians, it is interesting to note that the recent rally has brought the December 2017 copper(x2)/gold spread right up to the declining 200-day Moving Average.

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December 2017 Copper (x2) Gold spread (200-day MA) daily

The 200-day MA is a widely-watched indicator that trend followers often use as their line of delineation for which side of the market to be on.  It certainly has merit.  Many studies have backed the use of the 200-day MA for market timing.

If the December 2017 copper(x2)/gold spread can make a sustained close above the 200-day MA for the first time since May of 2015, it could turn the tide for this bear market.  If so, expect it to continue the recent trend of profitable liquidation orders.

Unlike traditional trend followers, however, a scale trader hopes that the move higher does not occur in a straight line.  Countertrend pullbacks are needed to reenter positions after profitable liquidations.  However, the market is in control of what happens next.  Not us.  All we can do is have a plan in place for how to react in either direction.