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.

kansas-city-chicago-wheat-spread-nearest-futures-daily

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.

december-kansas-city-chicago-wheat-spread-daily-30-day-ma

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. 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s