Sugar/Corn Spread: Roll and Add More

Bears Firmly In Control

The IMC blog entered a short position in the May sugar/corn spread on February 13th when the value of one sugar contract closed at a premium of +$3,251.30 over the value of one corn contract.

Early this month, the corn contract finally closed with the premium value.  That hasn’t happened since last June.  We are taking this as confirmation that the expected bear market is firmly intact.  Based on history, we expect to see this spread decline several thousand more dollars before it’s all said and done.

July Sugar Corn spread daily

July Sugar Corn spread daily

Today, we are going to do two things.  First, roll the May contracts to the July contracts.  First Notice Day is just a few days off.

Secondly, we are going to add to the short position.  The spread has been consolidating in a tight range for the last three weeks.  This pattern gives us a low-risk setup to get short on a breakout of the range and risk to the other side of the range.

Trade Strategy:

Buy back the short May sugar contract, sell one July sugar contract short, sell the May corn contract, and simultaneously buy one July corn contract at the market-on-close on Tuesday, April 25th.  Risk the July spread to a two-consecutive day close above +$4,000 (premium sugar). 

 “Add-On” Trade Strategy:

Place a hypothetical contingency order to sell one 112,000 lb. July sugar contract and simultaneously buy one 5,000 bushel July corn contract if the spread closes below the April 5th low of -$436.20 (premium corn).  If filled, liquidate the position on a three-consecutive day close above the April high (currently at +$437.10). 

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Cocoa/Sugar Spread: Getting Off the Ride

The Bear Campaign

The IMC blog began a short-selling campaign in the cocoa/sugar spread at the end of September 2015.  The nearly one and a half year ride came to an end last week when the spread finally made a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.  This was the first such occurrence since late April of last year.

Due to ‘add-on’ positions after the trade was initiated, several rollovers, and a change in the spread ratio, the blog was short the May cocoa/sugar spread from the equivalents of +$21,514.80, +$18,158.60, +$14,949.20, and +$1,199.20.  The premium on all the spreads was to the cocoa contract value.

Cocoa Sugar spread daily (100-day MA)

Cocoa Sugar spread daily (100-day MA)

The exit price occurred at the March 14th close at +$240.80, which happened to be the first time this year that the value of the cocoa contract closed at a premium to the value of the sugar contract.

The Results Are In

Excluding commissions, the trade resulted in a total profit of +$54,858.60.  When you take into account the fact that the initial risk in the trade was $5,409.20 (based on the September 30, 2015 entry) the trade resulted in a ten-fold return.

Ironically, the initial risk when the trade was entered was more than double what I had anticipated.  The reason for that was because the spread reversed from a multi-year high to a two and a half month low in just five trading days.  If the volatility had not spiked via a big expansion in the trading range, the trade could have produced a return of at least 20-to-1.  But hey, we have no reason to complain when we still made a profit that was ten times the risk!

Staying On the Radar

Although the blog is no longer in the cocoa/sugar spread, it does not mean that we will forget about it.  As a matter of fact, we are watching (and hoping!) to see if the bullish trend change will fail and put the spread back on track for new lows.

So far, the contract low for the May cocoa/sugar spread was established on Valentine’s Day at a low of -$3,764.40 (premium sugar).  If we are lucky, the spread will return to this level and maybe even break below it.

May Cocoa Sugar spread daily

May Cocoa Sugar spread daily

Does that mean we are looking to reenter a short position?  Not exactly.  The blog aims to initiate a trade position after a spread has come off of an extreme reading where prior price excursions have proven rare and unsustainable.  Furthermore, it has to be in the direction of a trend that is in agreement with a historical reversion to the mean.  These requirements currently exclude a short sale on the cocoa/sugar spread.

Bears Breed…Bulls?!

The reason that we are hoping for a break to new lows is because it would put the cocoa/sugar spread on our candidate list for a potential trade on the long side.

Say what?!

Yep, you read that right.  We will be looking for a setup to go long on the spread.  Historically, bear markets in the cocoa/sugar spread have been near completion when the spread has declined below -$3,500 (premium sugar).

After a month end close below -$3,500 (premium sugar) on the nearest-futures monthly chart, the spread has usually bottomed out within a few months.  The longest it took was seven months when the spread closed below -$3,500 in June 1989 and hit the final closing low in January 1990.  Furthermore, the spread has never stayed below -$3,500 on a monthly closing-basis for more than a year.

Cocoa Sugar spread (nearest-futures) monthly

Cocoa Sugar spread (nearest-futures) monthly

Here’s the catch, though: although the cocoa/sugar spread closed below -$3,500 on the daily timeframe last month, it has not yet closed below -$3,500 on the nearest-futures monthly timeframe.  Last month’s close was -$2,107.60.  Therefore, the spread still hasn’t triggered our qualification for a trade candidate on the long side.

Even though we don’t currently see anything to do in the cocoa/sugar spread, now you know why we are continuing to at least monitor it.  I highly suggest you put this on your watch list as well.

 

Cocoa/Sugar Spread: Roll to May Contracts

The Bear Continues

The IMC blog has been on a short sale campaign in the cocoa/sugar spread for nearly seventeen months.  Thanks to the initial position and some ‘add-ons’ we picked up, the blog is short a March cocoa/sugar spread from the equivalent of +$21,866 (premium cocoa), short a second March cocoa/sugar spread from the equivalent of +$18,509.80 (premium cocoa), short a third March cocoa/sugar spread from the equivalent of +$15,300.40 (premium cocoa), and short a fourth March cocoa/sugar spread from the equivalent of +$1,550.40 (premium cocoa).

The bear market remains in full force, so we will remain short.  Currently, it will take a two-consecutive day close above the declining 100-day Moving Average to tell us that the trend has changed and prompt us to take the money and run.  That hasn’t happened since last April.

cocoa-sugar-spread-nearest-futures-daily

Cocoa Sugar spread (nearest-futures) daily

Furthermore, we are waiting to see what happens if/when the spread drops to -$4,000 (premium sugar).  Prior bear markets in the cocoa/sugar spread ended after this level was reached and set the stage for bull markets.  That means we will start thinking about trading the long side of the cocoa/sugar spread if it makes down to this area.

Trade Strategy:

On the four March cocoa/sugar spreads entered at the equivalents of +$21,866, +$18,509.80, +$15,300.40, and +$1,550.40 (premium cocoa), roll to the May spreads at the market-on-close on Friday, February 24th.  Risk all four spreads to a two-consecutive day close above the declining 100-day Moving Average, basis the nearest-futures.  

 

Sugar/Corn Spread: Strap In For the Next Bear Market

Early Stage Bear Market

The spread between sugar and corn may have ended a four-year bull market right when Q4 started last year.  If so, historical precedent suggests that it could now be at the very start of a multi-year decline.  That means there should be plenty of opportunity, both in terms of time and price, to take advantage of it.  Spread traders would be wise to start paying attention to this one.

To even consider a potential spread trade, though, the IMC blog first likes to establish that the markets in question have historically exhibited a strong correlation.  It can’t be just a short-term fluke.

In the past, there have been strange anomaly periods where markets with no fundamental relationship (like soybeans and silver, for example) were somehow highly-correlated for a few months.  But that certainly doesn’t mean that it’s got the makings of a good spread trade candidate.

There have also been market crisis situations where markets that are normally unrelated all go to a correlation of one.  Remember the crash of ’87 or the Great Financial Crisis of ’08?  The temporary strong correlation of all markets was the product of a liquidity crisis and dissipated once the crisis has passed.

Therefore, we want to see decades of price history where a couple of markets have shown correlation.

Cousins, Not Twins

Go back the last thirty-five years on a weekly closing-basis, and you will see that the prices of sugar and corn are pretty correlated.  This is likely due to the fact that both markets are used as derivatives to produce ethanol.  Also, sugar and corn syrup are both used as sweeteners in food products.

Now, you’ll also notice that the correlation would strengthen and weaken.  This ebb and flow of correlation is because the crops have some different uses, different main production areas, and several other fundamental differences that can impact one crop without directly impacting the other.  So they may not look exactly like identical twins when you compare the charts, but they at least look related enough to be first cousins!

sugar-corn-overlay-nearest-futures-weekly

Sugar Corn overlay (nearest-futures) weekly

Despite the inconsistency in the correlation periods –heck, maybe even because of it- the spread between sugar and corn has offered some great trading opportunities.  This often was the case after one market had outperformed the other for a prolonged period of time or when there was a temporary disconnect where one market was trending while the other was static or even trending in the opposite direction.  Eventually, this divergence would end and a major price reversal in the spread would occur.

Historical Price Boundaries

A sugar futures contract controls 112,000 pounds of sugar and a corn futures contract controls 5,000 bushels of corn.  So the blog converts the contracts to their market value before plotting a spread in order to simplify and clarify things.

About four months ago, the nearest-futures sugar contract was worth almost +$9,300 more a nearest-futures corn contract.  Not only was this significant by being the highest premium in over six and a half years, but it was also only the fourth time in the last four decades that a sugar contract has ever reached a premium of +$9k or more over a corn contract.  The prior three occurrences were followed my multi-year bear markets.  Therefore, it would not be surprising if a major decline was on the horizon.

sugar-corn-spread-nearest-futures-weeklyFor how long?  And, more importantly, how big?!

Consider the prior three bear markets that started above the +$9k mark:

The bear market that started from the October 1980 top lasted three years and nine months.  The decline from top to bottom was approximately $44,300.

The bear market that started from the January 2006 top lasted two years and six months.  The decline from top to bottom was approximately $35,300.

The bear market that started from the January 2010 top lasted two years and seven months.  The decline from top to bottom was approximately $33,800.

The sugar/corn spread seems to act like a pendulum.  After reaching an extreme on the high side, the bear markets that followed these three peaks crushed the spread to levels rarely seen on the downside.  You can see that there have only been a few instances where the sugar contract value traded at a discount of -$12k or more to the value of a corn contract.  Down at those levels, the spread always turned out to be a great buying opportunity again!

This price history certainly does not guarantee that the sugar/corn spread will drop tens of thousands of dollars over the next two or three years.  But it does show us what occurred before, which tells us the potential and the probabilities of what could occur.

The Ratio Test

As always, we like to look at the ratio between the markets as well.  This helps normalize the prices.  It’s a filter that tells us if the market relationship really is truly at an extreme level by historical standards.

In early October the nearest-futures sugar/corn ratio peaked at 1.54:1.  So the value of a sugar contract was worth 54% more than the value of a corn contract.  Looking at the weekly price data of the last forty years, this was only the fifth bull market that pushed the ratio to 1.5:1 or higher.  Therefore, the ratio confirms what the spread is telling us: Sugar is just way to expensive in comparison to corn.

sugar-corn-ratio-nearest-futures-weekly

Sugar Corn ratio (nearest-futures) weekly

On the other side of the coin, sugar is historically too cheap in comparison to corn when the ratio drops to 0.5:1 or lower.  At that point, one sugar contract is worth only half as much as a corn contract.  That hasn’t happened since the financial crisis.

The Price Action

Over the last two and a half years, the 150-day Moving Average has been a reliable trend indicator for the nearest-futures sugar/corn spread.  When the spread closed below the 150-day MA at the end of November 2014 it continued its descent until August of 2015.

After a failed breakout above the 150-day MA in the first part of September 2015, the spread made a second attempt at the end of the month and was successful.  This launched a runaway move that lasted for about a year.

sugar-corn-spread-nearest-futures-daily

Sugar Corn spread (nearest-futures) daily

Now, I do want to point out that two failed bearish trend change signals occurred in February and April of 2016.  However, both signals were reversed within a couple of days.

Two months ago, the nearest-futures sugar/corn spread made a clean break below the 150-day MA.  It has stayed below it the whole time since.  Therefore, a trend follower would have to consider the spread to be in a bearish trend at the moment.

Zeroing In

On the nearest-futures chart, the sugar/corn spread rallied off the December low and has been stuck in consolidation mode for the last month.  The spread scraped against resistance at the 150-day MA.  If it starts to roll over here, a second leg down could commence.

Looking at the May sugar/corn spread specifically, we can speed things up a bit and measure the trend according to the 50-day Moving Average.  When this spread cracked the 50-day MA in October it signaled a bearish trend change.  The spread then closed back above the 50-day MA again once the New Year began and turned bullish.

Interestingly, the uptrend did not continue after the January trend change signal.  The May sugar/corn spread has been stuck in a sideways trading range.  A break below the January low and close back under the 50-day MA would put the ball back in the bear’s court.

may-sugar-corn-spread-daily

May Sugar Corn spread daily

Let’s put this all in context.  The fact that the nearest-futures spread peaked last year at levels that have previously led to major bear markets…

The fact that the sugar/corn ratio also reached historic extremes that have always been unsustainable…

The fact that the spread is still in a downtrend on the nearest-futures chart by virtue of the fact that it remains below the 150-day MA…

One would have to think that selling the May sugar/corn spread on a close below the 50-day MA would be a trade worth taking!

Trade Strategy:

Place a hypothetical contingency order to sell one 112,000 lb. May sugar contract and simultaneously buy one 5,000 bushel May corn contract if the spread closes below the 50-day MA (currently around +$3,666).  If filled, liquidate the position on a two-consecutive day close $500 above the 2017 high that precedes the entry (currently at +$4,923.90). 

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.

 

Cocoa/Sugar Spread: Another Short Sale Setup

Riding the Bear

The IMC blog has been in a profitable trade in the cocoa/sugar (x2) spread for over a year now.  Based on adjustments for rollovers, we’re holding a short position in the March cocoa/sugar (x2) spread that was entered on September 30th at the equivalent of +$37.20 (premium cocoa), a second ‘add-on’ position that was entered on February 18th, at the equivalent of -$3,319 (premium sugar), and a third ‘add-on’ position that was entered on April 19th at the equivalent of -$6,528.40 (premium sugar).

march-cocoa-sugar-x2-spread-daily-75-day-ma

March Cocoa Sugar (x2) spread daily (75-day MA)

Over the last week and a half, the spread has bounced from trading near contract lows to closing just above resistance between the November 1st bounce high of -$21,195.60 and the declining 75-day Moving Average around -$21,336.20.  It’s do-or-die right here.

On the nearest-futures chart, the cocoa/sugar (x2) spread is sitting just below that same resistance level between the November 1st bounce high and the declining 75-day Moving Average.

cocoa-sugar-x2-spread-nearest-futures-daily-75-day-ma

Cocoa Sugar (x2) spread (nearest-futures) daily (75-day MA)

In addition, the nearest-futures spread has currently rallied as much as $4,158.80 from the recent low.  Since the bull market ended in September of 2015, the spread has made four other notable bounces of $5,076.40 off the January low, $5,679.20 off the March low, $4,041.60 off the July low, and $5,014 off the October low.  Based on this symmetry, the bounce could be close to completed.

Reading the Ratio

The ratio between the value of a 10-tonne cocoa contract and a 112,000 lb. sugar contract recently tagged 1:1 for the first time in over four years.  Prior bull markets that peaked at a ratio of 2.5:1 or higher were followed by multi-year bear markets that took the ratio below 0.8:1 each time.  Therefore, the current bounce could be nothing more than another bear market rally.  These are short sale opportunities and will remain so until the trend changes.

Due the decline in the ratio, the IMC blog will adapt by taking additional ‘add-on’ signals for a spread between one cocoa contract and one sugar contract.  This keeps it more dollar neutral.

march-cocoa-sugar-spread-daily-50-day-ma

March Cocoa Sugar spread daily (50-day MA)

Viewing the March cocoa/sugar spread, one can easily see that the downtrend remains fully intact and that bounces into the declining 50-day Moving Average have been selling opportunities.  Therefore, we have a green light to add to short positions right here.

Trade Strategy for ‘Add-On’ Position:

Work a hypothetical contingency order to sell one 10-ton March cocoa contract and simultaneously buy one 112,000 lb. March sugar contracts at +$1,550 (premium cocoa) or better.  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above +$3,000 (premium cocoa).   

 

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.

Cocoa/Sugar Spread: Roll From the Summer Spreads

Keep Rollin’ Along

The IMC blog has been on a bear market campaign in the cocoa/sugar (x2) spread for several months.  We are currently holding a short position in the July cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$2,565.60 (premium cocoa), a second ‘add-on’ position that was entered at -$790.60 (premium sugar) on February 18th, and a third ‘add-on’ position that was entered at -$4,000 (premium sugar) on April 19th.

The First Notice Day for the July sugar contract is this week and liquidity in cocoa is well established in the September contracts.  Therefore, we’re going to roll the position into the autumn contracts.

Cocoa Sugar (x2) spread (nearest-futures) weeklyA bounce into the declining 75-day Moving Average could offer another short sale opportunity.  The bounces in December, February, and April all ended after the spread clipped the 75-day MA, so we’ll look to take advantage of this pattern.  Also, if/ when the cocoa/sugar (x2) spread reaches our minimum downside target of to -$20,000 (premium sugar) we will tighten the exit parameters on the position.

Trade Strategy:

On the hypothetical short July cocoa/sugar (x2) spreads entered at the equivalent of +$2,565.60 (premium cocoa), -$790.60 (premium sugar), and -$4,000 (premium sugar), roll to the September cocoa and October sugar contracts at the market-on-close on Tuesday, June 28th. 

Cocoa/Sugar Spread: Rollin’ Out

Buying Time

Currently, we are holding a short position in the May cocoa/sugar (x2) spread that was entered on September 30th from the equivalent of +$2,856 (premium cocoa) and a second ‘add-on’ position in the May cocoa/sugar (x2) spread that was entered at -$500 (premium sugar) on February 18th.

A third spread -which was another ‘add-on’ position – was entered in the July spread at -$4,000 (premium sugar) on April 19th.

We just passed the First Notice Day for May cocoa and the First Notice Day for May sugar is quickly approaching.  Therefore, we are going to roll the May spreads over to the July contracts.

Cocoa Sugar (x2) spread (nearest-futures) monthly

Cocoa Sugar (x2) spread (nearest-futures) monthly

Remember that previous rallies to +$4,500 (premium cocoa) or higher on the nearest-futures monthly chart were ultimately followed by major bear markets.  Each one crushed the cocoa/sugar (x2) spread down to -$20,000 (premium sugar) or lower.  Therefore, the spread still has a long, long way to go before we expect a bear market finale.  We’ll continue to add to the short position when the right setups materialize.

Trade Strategy:

On the hypothetical short May cocoa/sugar (x2) spread entered at the equivalent of +$2,856 (premium cocoa) and the ‘add-on’ position entered at -$500 (premium sugar), roll to the July contracts at the market-on-close on Friday, April 22nd. 

Cocoa/Sugar Spread: Adding More

Satisfying Our Sweet Tooth

This morning the IMC blog added a third short position in the July cocoa/sugar (x2) spread when it rallied to -$4,000 (premium sugar).  Initially, this ‘add-on’ spread will be liquidated on a two-consecutive day close above -$2,000 (premium sugar).

July Cocoa Sugar (x2) spread daily

July Cocoa Sugar (x2) spread daily

Over the last several months, the blog has increased the short position in the cocoa/sugar (x2) spread by three-fold.  With a minimum downside target of -$20,000, we hope to continue adding.  We’ll let you know if we see another setup.