Cocoa/Sugar Spread: Adjust the Ratio

Recalibration

The IMC blog is still positioned on the right side of the bear market in the cocoa/sugar (x2) spread.  Currently, we are short a March cocoa/sugar (x2) spread from the equivalent of +$37.20 (premium cocoa) that was entered on September 30th of 2015!  We added a second ‘add-on’ position at the equivalent of -$3,319 (premium sugar) on February 18th and then we added a third ‘add-on’ position at the equivalent of -$6,528.40 (premium sugar) on April 19th.

The spread continued to decline so much that when our next setup to add more occurred, we decided to spread one cocoa contract against just one sugar contract instead of two sugar contracts this time.  So on November 21st, the blog sold a fourth ‘add-on’ position at +$1,550.40 (premium cocoa).

cocoa-sugar-spread-nearest-futures-weeklyWhat we did not do, however, was recalibrate our older spread positions to reflect the current ratio of approximately 1:1.  Given the fact that the prior bear market declines in the cocoa/sugar spread did not end until one cocoa contract had a premium of +$4,000 or more over one sugar contract, it makes sense to adjust our position to reflect the current ratio of the cocoa/sugar relationship and stay short.

Since there’s no time like the present, we want to go ahead and get that done.  We are going to make this our last act of 2016!

Trade Strategy:

On the short positions in the March cocoa/sugar (x2) spread entered at the equivalent of +$37.20 (premium cocoa), the equivalent of -$3,319 (premium sugar), and the equivalent of -$6,528.40 (premium sugar), exit one of the two sugar contracts in each spread at the market-on-close on Thursday, December 29th.  This will change the ratio for each spread to 1:1.  Risk all four spreads to a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.

 

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Platinum/Gold Spread: Roll to the April Contracts

The Long Road

In September of 2015, the IMC blog bought an unleveraged platinum/gold spread at the equivalent of -$201.20 (premium gold).

We added leverage in April 2016 when we purchased an ‘add-on’ investment position, but the spread moved adversely and knocked this one out a couple of months later.

So far, this position has not made us any money.  But we will continue to pursue it.

Why?!

First of all, commodity spreads show a strong tendency of mean reversion over time.  The platinum/gold spread is no different.

Secondly, the spread has set new records in terms of both price and time this year.  Since it’s a mean-reverting spread, the new price and time extremes should only increase the probabilities of a severe snapback in the future.

On June 27th, the platinum/gold spread sank to an all-time low of -$343.30 (premium gold).  It then came close to matching it on October 21st when it hit -$337.30 (premium gold).  Interestingly, the platinum/gold ratio touched a thirty-three year low of 0.74:1 on June 27th and then hit a slightly lower low of 0.7335:1 on October 21st.  The ratio hasn’t been down there since October of 1982.

platinum-gold-spread-nearest-futures-weekly

Platinum Gold spread (nearest-futures) weekly

In terms of time, we are only three weeks away from marking the two-year anniversary of platinum trading at a discount to gold.  This broke the previous record inversion streak of one year and seven months that occurred from September 1981 and April 1983.

So even though the platinum/gold spread has not performed for us yet, we will continue to exercise patience and money management so we can stick to the original plan.  It’s nothing more than a waiting game right now.

Investment Strategy:

For tracking purposes, the blog will liquidate the long January-February platinum/gold spread investment position and simultaneously enter a long investment position in the April platinum/gold spread at the market-on-close on Tuesday, December 27th.  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.

Bund/BOBL Spread: Roll With the Bear

Out With the Old, In With the New

The IMC blog entered a short position in the December Bund/BOBL spread at 31.81 on October 10th.  The December European treasury futures contracts are expiring soon, so it’s time to roll over into the March contracts.

We noted in September that the close below the rising 30-bar Moving Average on the nearest-futures weekly chart for the first time in a year could have marked the beginning of a multi-month decline.  That’s how it played out the last two times the spread cracked the weekly 30-bar MA.

euro-bund-euro-bobl-spread-nearest-futures-weekly

Euro Bund Euro BOBL spread (nearest-futures) weekly

Another bearish development occurred one month ago.  The Bund/BOBL spread closed back below the 2015 high of 30.58.  Remember the old charting rule: Old resistance, once broken, becomes new support.  Well, that support level gave out four weeks ago.  This confirms that the trend has indeed turned bearish.

Where To Now?

A Fibonacci .618 retracement of the move from the 2015 low to the 2016 high would take the spread down to 26.13.  That’s another three full points from here.

But that does not mean the decline has to stop at Fibonacci support.

If the current decline from the 2016 record high replicates the 9.40-point decline from last year’s record high, the Bund/BOBL spread would hit 24.74 before it’s all over.

The bottom line is that the spread continues to break layers of technical support and the next targeted support area is still a few full points away.  Therefore, it makes sense to simply roll the contracts over and stay short.

Heck, we may even be willing to add to the position if the right setup comes along!  We’ll keep you posted if we see something interesting.

Trade Strategy:

Exit the hypothetical short December Bund/BOBL spread and simultaneously enter a short March Bund/BOBL spread at the market-on-close on Wednesday, December 7th.  Initially, the spread will be liquidated on a two-consecutive day close above 34.30. 

Aussie/Kiwi Spread: Rollover and Prepare to Add More

Exit Christmas Contracts

The IMC blog entered a long position in the December Australian dollar/New Zealand dollar spread at 3.42 cents (premium Aussie) on September 22nd.  With the upcoming expiration of the December contracts, it is time to roll to the March spread.

Two and a half months after entering this spread, it is sitting at nearly the same level as the purchase price!  As they say down here in the South, “This dog won’t hunt.”

aussie-kiwi-spread-nearest-futures-weekly

Aussie $ Kiwi$ spread (nearest-futures) weekly

However, the blog is maintaining a long position because the macro view indicates that we are holding the spread at a price that is historically cheap and previously unsustainable.  As you can see on the weekly nearest-futures chart, buying the spread below four cents would have led to profitable trades as the spread more than doubled off the lows.  So we’re willing to sit patiently to see if this sort of wager will pay off once again.

Near-term Price Hurdle

The March Australian dollar/New Zealand dollar spread rallied in the late summer and peaked out at a price of 5.31 cents on August 9th.  After a plunge to new multi-month lows in mid-September, the March spread once again reversed and ran higher.  The one-month run topped out at 5.27 cents on October 14th.

march-2017-aussie-kiwi-spread-daily

March 2017 Aussie $ Kiwi$ spread daily

The similar August and October highs form a price hurdle for the March Australian dollar/New Zealand dollar spread.  However, this is good news!

Why?

Because the price hurdle creates a clearly-defined breakout point.  A sustained close above this level would signal that the spread is finally serious about making a recovery.  Since such an event would mean that the current long position has an open profit to cushion it, aggressive traders could add to long Australian dollar/New Zealand dollar spread position on the breakout.

Trade Strategy:

Exit the long December Australian dollar/New Zealand spread and simultaneously purchase a March Australian dollar/New Zealand spread at the market-on-close on Wednesday, December 7th.  Initially, the spread will be liquidated on a two-consecutive day close below 2.00 cents. 

‘Add-On’ Trade Strategy:

For tracking purposes, the IMC blog will make a hypothetical ‘add-on’ trade by buying one March Australian dollar contract and simultaneously selling one March New Zealand dollar contract if the spread closes above 5.31 cents (premium Aussie).  If filled, the spread will initially be liquidated on a two-consecutive day close below 3.42 cents. 

Loonie/Kiwi Spread: On the Cusp of a Trend Change

Parameter Revision

The IMC blog is working a hypothetical order to buy the December Canadian dollar/New Zealand dollar spread on a breakout above the August high.  We’re going to update the parameters for this trade, changing both the contracts traded and the entry level.

First of all, we are now going to start tracking and trading the March 2017 contracts.  The December currency contracts will be history in the next week or so.

Secondly, instead of waiting for a breakout above the August high, we are going to go long on a breakout above the declining 100-day Moving Average.  The reason for this is that breakouts above/below the 100-day MA on the nearest-futures chart have been highly accurate in identifying trend changes over the last several years.  More often than not, the move continued in the direction of the breakout for months afterward and the moves were hundreds of basis points in size.  That’s tradable.

canadian-kiwi-spread-daily-100-day-ma

Canadian $ Kiwi $ spread daily (100-day MA)

In addition, the Canadian dollar/New Zealand dollar spread had previously bottomed at 3.87 cents in March 2014, 3.97 cents in March 2015, and 3.84 cents in December 2015.  This created a floor of support around the four-cent mark.

The four-cent support level was breached in September and the spread recovered a month later.

The spread once again sank below four cents in the second half of October.  This time, it accelerated lower and posted a multi-decade low of 1.36 cents on November 8th.

But just two weeks later, the Canadian dollar/New Zealand dollar spread had rocketed back up to the four-cent mark and has been flip-flopping around it since.  The fact that the spread just can’t stay below the four-cent mark indicates that it is undervalued down here.  This is supportive of a long position.  If we can combine that with a sustained close back above the 100-day MA for the first time since early June, it would greatly increase the probabilities that the spread finally makes a sizable run higher.

Trade Strategy:

Cancel the order to buy the December Canadian dollar/New Zealand dollar spread and place a new hypothetical order to buy one March Canadian dollar contract and simultaneously sell one March New Zealand dollar contract if the March spread closes above the 100-day Moving Average (currently around 4.42 cents).  If filled, the spread will initially be liquidated on a two-consecutive day close below the November 29th reaction low of 3.54 cents. 

 

Euro Bund/T-Note Spread: End of the Run?

At the Limit

Euro bunds have been outperforming the US 10-year notes ever since the end of the Great Financial Crisis eight years ago.  This is because the US economy has been outperforming the European economy.

You read that right.

Our economy has been doing better, but Europe’s 10-year treasury has been moving up faster than ours.  This is because Treasury prices are inversely correlated to Treasury interest rates.  So another way of saying this is that Europe’s interest rates have been dropping fast than ours.

But the charts suggest that this could be about to change.

euro-bund-t-note-spread-nearest-futures-weekly

Euro Bund T-note spread (nearest-futures) weekly

First of all, our nearly eight-year run in the bund/T-note spread is similar in duration to the bull market that started during the early ‘90s.  The spread bottomed at the end of the summer 1992 and topped in late spring of 2000.  A decline followed that lasted nearly two and a half years.

Secondly, the size of the current bull market is mammoth.  The 1992-2000 bull market ran the spread up 31 1/2 points from the low.  That was quite an accomplishment.  But our bull ran matched that gain two years ago.  A sizable correction followed soon after, but the next leg higher took it into record gains as our bull market has now put on 42 full points since the December 2008 bottom.

Third Time’s the Charm

On the daily timeframe, the nearest-futures Euro bund/T-note spread made some noteworthy tops around the 36.00 level this year: The spread peaked at 35.99 on March 1st, it peaked again at 36.33 on August 26th, and may have peaked once more this very week at 36.38 on November 28th.

euro-bund-t-note-spread-nearest-futures-daily

Euro Bund T-note spread (nearest-futures) daily

Based on the prior two tops, it stands to reason that the spread will at least descend to the 32.00 area again.  This is a good enough reason to take a stab at the short side of the Euro bund/T-note spread.

However, if this really is the end of the multi-year bull market, a sustained close below 32.00 could indicate that this is only the tip of the iceberg.  Based on history, it could be just the start of a multi-year bear market for the Euro bund/T-note spread.

Wash & Rinse

Now this is interesting.  The December Euro bund/T-note spread will expire in a couple of weeks.  The next spread to trade will be the March spread.  Usually, the March spread should be priced at a discount to the December spread to account for the carry-charge.  (This is because the interest rates on the further contracts are normally higher and the interest rate is inverse to the price).  But the March spread is priced at a premium of more than two and a quarter points over the December spread.  As a short seller, this is a gift.

The reason for the higher price in the March spread is because the March T-note is pricing in the expected increase in US rates.  The further divergence in monetary policy between Europe and the US is widening this spread.

march-2017-euro-bund-t-note-spread-daily

March 2017 Euro Bund T-note spread daily

The chart pattern of the March Euro bund/T-note spread is what has my attention, though.  This spread had a double top established between the August 26th high of 37.81 and the September 28th high of 37.81.  Once this resistance barrier was cracked on November 22nd, the spread had nothing to stop it from rocketing higher and the double top barrier became a floor of support.

This morning the March Euro bund/T-note spread is trading back below the old double top.  A close below this price would indicate a failed breakout attempt.  I call this a Wash & Rinse pattern.  Quite often, a failed breakout can lead to a sizable move in the opposite direction.  Therefore, a close below the August and September highs would be a short sale signal worth taking.

Trade Strategy:

Place a hypothetical order to sell one March Euro bund contract and simultaneously buy one March T-note contract if the spread closes below 37.81.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 38.81). 

Copper/Crude Spread: Switching Bets From Red to Black

The Correlation

Copper and crude oil prices are strongly correlated.  You can look at the last three decades of price history and see that this is the case.  This makes is a great pairing for potential spread trades.

Fundamentally, this correlation works because of the demand side of things.  The two markets are connected to economic growth.  When the economy is doing well, consumption of both commodities increases.  Conversely, consumption of both copper and oil slumps when the economy slows down.

copper-crude-oil-overaly-nearest-futures-weekly

Copper Crude Oil overlay (nearest-futures) weekly

Thanks to the big difference in the supply side, however, there can occasionally be big divergences between copper and crude.  A mine strike in South America will move copper immediately and have no effect on oil prices.  Likewise, a change in OPEC policy immediately impacts oil prices but the copper market may not respond at all.

The demand side connection and the supply side disconnection create ebb and flow between these two markets that can generate spread trading opportunities.

Historical Boundaries

As readers know, the blog is interested in spread trade opportunities whenever an intermarket spread reaches or breaks the historical price boundaries.  This is because commodities are mean-reverting.  Whenever they reach the upper limits of the historical price range, it’s just a matter of time until it snaps back in the other direction.

Looking at the last three decades, it appears that the spread between the value of one 25,000 lb. copper futures contract and one 1,000 barrel crude oil futures contract reaches unsustainable levels when the nearest-futures spread gets to $17,000 (premium copper) or higher.

Sometimes the copper/crude spread has peaked within weeks of reaching the $17,000 price level.  Other times, it has taken several months to eventually turn over.  But every time it has reached $17,000 and beyond, a major bear market has followed.

copper-crude-oil-spread-nearest-futures-weekly

Copper Crude Oil spread (nearest-futures) weekly

The bear markets have been doozies, too!  They carried on until the spread inverted and crude had a premium of at least $10,000 over the copper.  At that point, the bear market had swung the pendulum all the way to the other extreme where the copper/crude spread became a trade candidate on the long side.

As traders, that’s perfectly fine with us.  As a matter of fact, it’s preferable.  This means we can ride the spread back and forth, hopefully banking profits in both bull markets and bear markets.

Current Setup

Exactly three weeks ago, the nearest-futures copper/crude spread hit $17,000 (premium copper) for the first time in months.  It appeared to be on the way to reaching the February top near $24,000.  We were actually cheering for it.  Based on the current price action, however, it is quite possible that the Black Friday (November 25th) high marked the end of the run.

The March 2017 copper/crude spread previously peaked in Q1 of this year between the January 20th high of $13,605 and the March 4th high of $13,642.50.  This left a double top pattern in place and represented a major resistance level.

Once the spread broke through the double top on November 9th the price resistance immediately became price support for the spread.  This is a well-established charting rule.

The spread pulled back just below this support zone on November 21st when it closed at $13,367.50.  It immediately bounced the next day and raced to new highs by the end of the week.  This reaction validated the support level.

march-2017-copper-crude-oil-spread-daily

March 2017 copper crude oil spread daily

But as we start the new month today the spread is currently trading below both the Q1 double top and the November 21st reaction low.  A close below this level would signal that the November breakout has failed.  If so, it would warrant a short sale in the March 2017 copper/crude spread.

Trade Strategy:

Place a hypothetical contingency order to sell one March copper contract and simultaneously buy one March crude oil contract if the spread closes below $13,367.50 (premium copper).  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry (currently at $19,137.50).