Platinum/Gold Spread: Roll to Halloween Contracts

The Long Road

The blog is holding an unleveraged April platinum/gold spread from the equivalent of -$206.30 (premium gold).  It was originally entered in September of 2015.  Boy, it’s been a looooong year and a half.

Leveraged was briefly added in April 2016, but the ‘add-on’ investment position was liquidated just a couple of months later.  This was because the uptrend failed to materialize.

This unleveraged spread position is experimental as it deviates from our normal trading rules of getting in and then exiting if there is an adverse move.  The idea was that a mean reverting commodity spread at record lows (it hit an all-time low of -$343.30 on June 27th and then nearly matched it on October 21st when it traded to -$337.30) with a confirmation on the ratio (it registered a thirty-three year low of 0.7335:1 on October 21st) would be a temporary event.

Platinum Gold spread (nearest-futures) daily

Platinum Gold spread (nearest-futures) daily

Furthermore, platinum has been priced at a discount to gold for a record two years and two and a half months, which is substantially longer than the prior record inversion streak of one year and seven months (September 1981 and April 1983).  In terms of both price and time, the historic extremes argue that a major reversion is long overdue.

The $64,000 question, of course, is “when will it finally happen?!”

Until we get more clarity on the situation, we remain unleveraged on the position.  But once a breakout above -$200 takes place, we’ll pay closer attention.  When that happens, it will time for a challenge of the 2016 high at -$161.20.  If this hurdle is cleared, the odds are pretty good that this record bear market is finally over.  Until then, we’ll patiently roll the contracts and bide our time.

Investment Strategy:

For tracking purposes, the blog will liquidate the long April platinum/gold spread investment position and simultaneously enter a long investment position in the October platinum/gold spread at the market-on-close on Tuesday, March 28th.  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.

Crude/Nat Gas Spread: Catching The Falling Knife

Spreading the Energies

Some of my favorite spreads are in the energy sector.  In particular, I love to trade the crack spreads.  But there’s also another lesser-known energy spread in my bag of tricks: crude oil against natural gas.

A few years ago, the correlation between crude and nat gas broke down.  It lasted for a few years and was not resolved until 2014.  This made for some tough sledding for anyone trying to trade the two markets against each other.  But since the correlation has been back to normal over the last three years, the odds of successfully trading the spread have gone up.  To that end, it looks like a buying opportunity is shaping up right now.

Making Plans for Labor Day?!

Two days ago marked the first day of spring.  Ironically, the trade opportunity that popped up on my radar screen yesterday is for the Labor Day (September) contracts.  I guess that’s why these are called futures contracts, right?

A crude oil futures contract controls 1,000 barrels of crude and a natural gas futures contract controls 10,000 MMBtu (million British thermal units) of nat gas.  To simplify the spread, I plot the difference between the actual values of the contracts.

Over the last couple of years, one September crude oil contract has been worth anywhere from 40% more to a little more than double the value of one September natural gas contract.  Therefore, the blog has been plotting the spread between one crude oil contract and the sum of the value of two natural gas contracts.

Price Parameters

Yesterday the September crude oil/natural gas (x2) spread closed at -$15,930 (premium nat gas).  This was the lowest price it has been in fourteen months.

Notice that this was only the fourth time in the last year that the spread has closed at -$15,500 or lower.  The lowest closing price was the January 20, 2016 low of -$16,170 and the longest that it ever closed at -$15,500 or lower was two consecutive days.

September crude oil natural gas (x2) spread daily

September crude oil natural gas (x2) spread daily

Actually, I fudged on that count just slightly.  The August 2, 2016 close was -$15,430.  That’s only $70 away from the -$15,500 threshold, which is close enough in horseshoes and hand grenades.  So we’ll say it’s close enough for spread trading, too.

Each of the dips to -$15,500 or lower was followed by rebounds that took the September crude oil/natural gas (x2) spread north of -$6,000.  Now interestingly enough, each close above -$6,000 was also a short-lived excursion as well.  Once the spread achieved this level, it soon rolled over and plunged again.  It’s been a perfect trading range for nearly a year and a half.

In light of this, it looks like the trade opportunity here is to buy the spread now and look for a rally above -$6,000 before taking profits.  Also, an ‘add-on’ position could be purchased once the rebound starts.  So that’s exactly how the IMC blog is gonna play it.

Ratio Confirmation

The ratio between the values of a September crude oil contract and a September natural gas contract confirm what we’re seeing in the spread.  The ratio closed at 1.51:1 yesterday.  The last three times it closed at 1.52:1 or lower, a major recovery soon followed.

The biggest challenge for the ratio’s recovery happened in January 2016.  The ratio closed at 1.52:1 on January 12th and didn’t fully recover above this level until two weeks later.  During this time, the contract low of 1.4:1 was established on January 20th.

September crude oil natural gas ratio daily

September crude oil natural gas ratio daily

In the grand scheme of things, though, this extended stay at 1.52:1 or lower was not all that dramatic because the spread only stayed at -$15,500 or lower for two days.  This is why using both the spread and the ratio together is a good idea.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one September 1,000 barrel crude oil contract and simultaneously selling two September 10,000 MMBtu (million British thermal units) natural gas contracts at -$15,500 (premium nat gas) or better.  Initially, the spread will be liquidated on a three-day close below -$16,500.

Trade Strategy for ‘Add-On’ Position:

For tracking purposes, the blog will make a hypothetical trade by buying one September 1,000 barrel crude oil contract and simultaneously selling two September 10,000 MMBtu (million British thermal units) natural gas contracts on a close at -$13,000 (premium nat gas) or higher.  Initially, this ‘add-on’ spread will be liquidated on a two-day close below -$15,500.

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.

 

Bund/BOBL Spread: Roll to June

Thinking About Summer

The IMC blog is holding a short position in the March Bund/BOBL spread that was entered at the equivalent of 31.93 on October 10th.  March contracts expire soon, so we’re going to roll to the June contracts.

The June spread closed at 28.94 on Friday, which is nearly a one and a quarter point discount to the March spread.  This puts the new spread right at a support zone on the weekly nearest-futures chart between the December and January lows of 28.91 and 29.09, respectively.  Once this support level is broken, there is nothing to stop the Bund/BOBL spread from descending to the next technical support level at a weekly Fibonacci .618 retracement at 26.13 (as measured between the 2015 low and the 2016 high.

euro-bund-euro-bobl-spread-weekly

Euro Bund Euro BOBL spread weekly

If the spread does not end its decline somewhere around this important support level, it may try to replicate the 9.40-point decline from last year’s record high.  If so, the next downside target will be at 24.74.

Trade Strategy:

Exit the hypothetical short March Bund/BOBL spread and simultaneously enter a short June Bund/BOBL spread at the market-on-close on Monday, March 6th. 

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.  

 

T-bond/T-note Spread: Roll to the June Contracts

Waiting For the Next Shoe to Drop

The IMC blog initiated a short position in the March T-bond/T-note spread at 26-18 (premium bonds) on January 20th.  For the last month, we’ve had little to show for our efforts as the spread has remained range-bound.

However, the spread did flash a major bearish signal back in early October when it closed below the widely-watch 200-day Moving Average for the first time since the first week of 2016.  We felt that the right move was to get short once the rally off the December low started to fade.  We still think that.

t-bond-t-note-spread-50-and-200-mas-daily

T-bond T-note spread (50 and 200 MAs) daily

A breakout above the current trading range would be our signal to take a loss on this initial trade and get to the sidelines.  If that occurs, it would increase the possibility of a rally to resistance at the declining 200-day MA where we would watch for a setup to take another crack at it.  Until then, we simply stay short.

First Notice Day for the March treasury contracts is on Monday.  Therefore, we have to roll to the June contracts today in order to maintain our position.

Trade Strategy:

Liquidate the short March T-bond/T-note spread and simultaneously enter a short June T-bond/T-note spread at the market-on-close on Friday, February 24th.  Risk the June spread to a two-day close above 27-24.  

Feeder/Corn Spread: Time to Rollover

Staying the Course

The IMC blog is holding a short position in the March feeder/corn (x4) spread from the equivalent of -$8,487.50 (premium corn).  We’ve been in this position since September 6th and patiently rolling over.  It’s time to do it again.

The spread will be rolled to the April and May contracts.  Based on the current prices, this will end up readjusting our equivalent entry level to somewhere around -$9,700 (premium corn).

feeders-corn-x4-spread-weekly

Feeders Corn (x4) spread weekly

So is it worthwhile to stay short?  We think so.  As you can see on the weekly timeframe, near-term support is located at last year’s low of -$18,837.50 (premium corn).  A clean break below this level could clear the way for a decline to the 2012 high of -$31,612.50.  Remember the technical charting rule: Old price resistance, once it has been broken, becomes new price support.

Trade Strategy:

Buy back the short 50,000 lb. March feeder cattle contract and simultaneously sell short an April feeder cattle contract at the market-on-close on Friday, February 24th.  Also, sell the four 5,000 bushel March corn contracts and simultaneously buy four 5,000 bushel May corn contracts at the market-on-close on Friday, February 24th.  Risk the April-May feeder/corn (x4) spread to a two-day close above even money.

 

Copper/Crude Spread: Rollover Update

Overdue Update  

The IMC blog entered a short position in the March copper/crude oil spread at +$13,265 (premium copper) on December 1st.  We rolled to the May contracts at the market-on-close last Friday (February 17th) because Monday was the Last Trading Day for the crude contract.

Alas, I had a blog post all queued up for the rollover last Friday and forgot to send it!  If you have a decent broker, however, they should have given you notice that the March crude contract needed to be liquidated or rolled.

On February 17th, the March copper/crude oil spread closed at +$14,275 and the May copper/crude oil spread closed at +$13,880.  Therefore, the discounted price would put us in the May spread at the equivalent of +$12,870.

may-copper-crude-oil-spread-daily

May Copper Crude Oil spread daily

As a reminder to why the blog initiated a short position, it is because the nearest-futures copper/crude oil spread signaled a bearish trend change after peaking out at +$20,640 in late November.  Historically, prior runs to +$17,000 or higher have been followed by major bear markets that hammered the copper/crude oil spread down to where crude oil had a premium of $10,000 or more over the copper.  Therefore, this could be just the start of a major decline.  We will be watching for setups to add to the short position along the way.

Copper/Gold Spread: Stay Long For More Upside

Keep ‘Em Rollin’

Currently, the blog is holding a long position in the March-February copper(x2)/gold spread from the equivalent of -$22,700 (premium gold).  It was entered on September 29th.

We’re still happy with the position.  But with the February gold contract expiring on Friday and the First Notice Day for the March copper contract hitting next Tuesday, it’s time to roll out into the later contracts.  Since the summer spread (July-June) is only about $300 more than the spring spread (May-April), we’re going to opt for more time and hop into the summer spread.

Since peaking out just above +$17k (premium copper) on December 5th, the July-June copper(x2)/gold spread has been stuck in a trading range.  The spread clipped the December 5th high last week, but has retreated once again.  What we need to see is a sustained close above the early December/mid-February high to get the momentum going again.  If that happens, the spread will stay on track for a run to the resistance zone between the 2015 high of +$28,190 (premium copper) and the November 2014 high of +$34,380 (premium copper).

july-june-copper-gold-spread-daily

July June Copper Gold spread daily

But remember that we mentioned before that the ratio between copper and gold (currently around 0.56:1) indicates that the spread could go substantially higher than the 2014/2015 price peaks!  Historically, prior occurrences where two copper contracts traded equal to or at a discount to the value of one gold contract were followed by major bull markets.  Each one lasted until two copper contracts were valued at a minimum premium of 66% over the value of one gold contract.  That puts the ratio at 1.66:1.

To hit this minimum ratio target of 1.66:1, the copper(x2)/gold spread would have to soar to somewhere between roughly +$53k (if the current copper price remained the same) and roughly +$78k (if the current gold price remained the same).

Based on this history, we are watching the spread carefully to see if a setup materializes to add to the long position after a breakout above the current trading range.  We’ll keep you posted if that happens.  For now, though, let’s roll out to the summer contracts.

Trade Strategy:

Sell the two March copper contracts and simultaneously buy two July copper contracts at the market-on-close on Wednesday, February 22nd.  Also, buy back the one short February gold contract and simultaneously sell one June gold contract at the market-on-close on Wednesday, February 22nd.

 

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).