Copper/Gold Spread: There May Be More Downside Ahead

Bag the Profits

IMC blog entered a long position in the July-June copper(x2)/gold spread from the equivalent of -$21,885 (premium gold) on September 29th.

The spread exploded higher at the end of last year.  A double top was established at similar highs in December and February.  At this point, the value of a pair of copper contracts had a 15% premium over the value of one gold contract.

Based on history, it seemed that this was merely a consolidation phase before the next leg higher.   After all, previous instances where two copper contracts traded at a discount to the value of one gold contract were followed by major trend reversals that ran the value of two copper contracts to a premium of 66% or more to the value of one gold contract.  This meant that the expectation of more upside was significant.

Alas, the market didn’t take out feelings, wishes, and hopes into account.  The copper(x2)/gold spread has been steadily eroding and taking back some of our open profits.  It’s now approaching the 200-day Moving Average as well.  A close below the 200-day MA for the first time since October could accelerate the decline.  Therefore, it makes sense to cash in our chips and wait for another hand to be dealt before we place anymore bets on this spread.  However, we won’t complain: the trade will net us a profit of nearly +$23,000 per spread.

July-June Copper Gold spread daily

July-June Copper Gold spread daily

For the December copper(x2)/gold spread, a Fibonacci .618 retracement of the run up would set technical support at -$12,428.  If the spread gets back down to this level, we will be watching to see if some sort of setup materializes to allow us back on board.

Trade Strategy:

Sell the two July copper contracts and simultaneously buy back the one short June gold contract at the market-on-close on Monday, June 5th. 

 

 

Copper/Crude Oil Spread: Watching For a Reversal

Looking to Reenter

Back on December 1st, the IMC blog entered a short position in the copper/crude oil spread at the equivalent of +$12,870 (premium copper), due to rollovers.

September Copper Crude Oil spread daily

September Copper Crude Oil spread daily

The blog was last holding a May spread.  It was liquidated at the market-on-close on April 20th at +$13,280 (premium copper) because the crude contract was expiring.

We are now stalking the September copper/crude oil spread for a short sale.  The blog did not roll into the September contracts automatically because the spread tested support at the early February low last week and bounced.  The plan is to get into the spread only if it breaks the similar lows from early February and last week.

Copper Crude Oil spread monthly

Copper Crude Oil spread monthly

Currently, it appears that the spread is headed for a test of the contract high that was posted just last month at +$17,882.50.  A breakout to new highs could push it right over the +$20k mark in a heartbeat.  If so, we will revise our short sale criteria.  History shows that this spread has been a good short sale after surpassing the +$20k level.

Trade Strategy:

Place a hypothetical contingency order to sell one September copper contract and simultaneously buy one September crude oil contract if the spread closes below +$10,000 (premium copper).  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry (currently at $17,882.50). 

If the spread closes above +$20,000, change the parameters to enter a short position if the spread closes below +$17,000.  If filled, liquidate the position on a two-consecutive day close above the contract high that precedes the entry. 

 

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.

 

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). 

Copper/Gold Spread: Roll to 2017 Contracts

Mean Reversion Underway

Last spring we said that the plunge in the copper(x2)/gold spread was setting up for the buying opportunity of a lifetime.  We reiterated this statement again in the summer.

Looks like we were right.

The IMC blog bought a December copper(x2)/gold spread at -$23,100 (premium gold) on September 29th.  Here we are two months later and the spread is trading at a nearly seventeen-month high of +$15,740 (premium copper)!

Currently, the spread appears to be on track for a price resistance zone between the 2015 high of +$28,190 (premium copper) and the November 2014 high of +$34,380 (premium copper).  Based on history, a rally into this area after an inversion in the spread seems very likely.  On the surface, this seems like it might be a good price zone to consider bagging the profits.

december-copper-x2-gold-spread-daily-3-years

December Copper (x2) Gold spread daily (3 years)

The ratio between copper and gold, however, argues that the spread will greatly exceed the price zone between the 2015 and November 2014 highs.

History shows that prior events where two copper contracts traded at or below the value of one gold contract were followed by reversals to where the two copper contracts would reach a minimum premium of 66% or more over the value of one gold contract.

Just to hit the minimum ratio of 1.66:1 from here, the copper(x2)/gold spread would have to soar to +$53,475 if the current copper price remained the same.  And if the current gold price remained the same, the spread would have to reach -you better sit down for this one- a nosebleed level of +$78,540!

Split the difference and you’re looking at a projected target of +$66,000 for the ratio to reach 1.66:1.

Therefore, it makes sense to simple roll the December spread over right here ahead of the First Notice Day for the December contracts and stay on the ride.

Trade Strategy:

Sell the two December copper contracts and simultaneously buy two March copper contracts at the market-on-close on Monday, November 28th.  Also, buy back the one short December gold contract and simultaneously sell one February gold contract at the market-on-close on Monday, November 28th.  This will roll the position from the December spread to the March-February spread.

December 2017 Copper/Gold Scale: Over $70k In Profits!

Planning the Work

On July 20th the blog implemented a scale trade strategy with the December 2017 copper(x2)/gold spread.  The scale ran on $5k intervals where a spread would be purchased every $5k down and then liquidated every $5k higher.

Keep in mind that the price intervals for the scale were based on closing prices.  This led to several better-than-expected purchase and liquidation prices since the closing price would often overshoot the exact $5k interval.

Furthermore, we launched the scale with several ‘bonus fills’ as the spread was well below our theoretical start level of -$5k where the value of the sum of two 25,000 lb. copper contracts is worth $5,000 less than the value of one 100 oz. gold contract.  We initially bought four December 2017 copper(x2)/gold spreads at -$21,135, yet we set the liquidations targets at -$15k, -$10k, -$5k, and even money.

Working the Plan

As the spread continued to drop, we picked up a couple more positions.  They were purchased at -$25,725 on August 1st and -$30,915 on September 6th.

The spread has been in a downtrend since the spring of 2015, so the drop to new record lows certainly was a test of a scale traders mettle (metal?) and conviction!

Finally, a bounce came.

The spread that was purchased on September 6th was sold on September 15th for a profit of +$6,800.

The spread that was purchased on August 1st was sold on October 4th for a profit of +$7,030.

Then we experienced nothing but radio silence for the next month.  The spread was bound in a tight range as it refused to drop low enough to trigger a repurchase or rally high enough to trip the wire on another exit.

Ringing the Cash Register

The silence was finally broken one week ago and the move has been explosive!  On November 7th the December 2017 copper(x2)/gold spread closed at -$13,090 and triggered a liquidation order.  This resulted in a profit of +$8,045.

On November 8th the December 2017 copper(x2)/gold spread closed at -$8,970 and triggered another liquidation order.  This resulted in a profit of +$12,165.

december-2017-copper-x2-gold-spread-daily

December 2017 Copper (x2) Gold spread daily

A third liquidation order for the week was triggered on November 9th the December 2017 copper(x2)/gold spread closed at -$4,985.  This resulted in a profit of +$16,150.

Finally, the last remaining position in our scale was liquidated on November 10th when the spread closed at +$375 and gave us a nice profit of +$21,510.

The total profit on this scale was +$71,700.

In just under four months.

Not too shabby!

What Next?

All positions in the scale have been liquidated.  So what now?  Simple: Leave the plan in place!  The blog will buy a December 2017 copper(x2)/gold spread on a close at -$5k or less, buy another one on a close at -$10k or less, buy another one on a close at -$15k or less, etc.  The purchase intervals are set every $5k lower.

On the other side of the coin, any purchased positions will be liquidated on a close that is $5k or better than the interval purchase level.  Note that the liquidation targets are based on the scale intervals, not the actual purchase price.  This means that any better-than-expected purchase prices will result in even bigger profits when it is finally liquidated.

If the copper(x2)/gold spread just goes to the moon from here and never dips back down into the scale trade zone, we will simply look elsewhere for other scale trading opportunities.  The strategy is applicable to most traditional commodities.  Therefore, we don’t have to be dependent on the metals or any one commodities sector.

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.

copper-x2-gold-spread-daily-nearest-futures-for-10-yrs

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.

december-copper-x2-gold-spread-daily-100-day

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.

copper-x2-gold-spread-weekly-underwater-line

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.

december-2017-copper-x2-gold-spread-200-day-ma-daily

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.

December 2017 Copper/Gold Scale: Just Bagged a Winner!

Sell Side Action…Finally!

The IMC blog pitched a crazy idea this summer about using a scale trading method to take advantage of price fluctuations in commodity spreads that are at extreme levels.  The gist of it is that one would continue buying spreads in intervals as prices declined and then sell those same spreads in intervals on price rebounds.

To keep things interesting and show you how it works, the blog is running a scale in the December 2017 copper(x2)/gold spread.  We are trading a $5k interval ladder where we will buy every $5k down and sell each position for a profit every $5k up.  Also, we are doing this on a closing-basis.

Since our scale started at -$5,000 (premium gold) and the spread was trading at -$21,135 when we launched it on July 20th, we entered four spread positions and considered them ‘bonus fills’ for the -$5k, -$10k, -$15k, and -$20k intervals.  They are for sale on closes above -$15k, -$10k, -$5k, and even money, respectively.

Another December 2017 copper(x2)/gold spread was purchased at -$25,725 on August 1st.  We are selling this one on a close at -$20k or higher.  So far, no action.

On September 6th the blog entered another December 2017 copper(x2)/gold spread at -$30,915, based on the close below -$30k criteria.  As per the plan, we offered it for sale on a close above -$25k.

Well, guess what happened?!  This last purchase was liquidated on September 15th at -$24,115!  That bags a profit of $6,800 on this position.

december-2017-copper-x2-gold-spread-daily

December 2017 copper (x2) gold spread daily

One of two things will happen next: The spread will continue to rally and close above -$20k and allow us to sell the position we bought at -$25,725, or else the spread will close back below -$30k and we will reenter the position that we just sold.

It will be interesting to see how everything plays out between now and November of 2017 when we finally have to think about rollovers.  Until then, let’s hope for some volatility to keep the December 2017 copper(x2)/gold spread banging around like a pinball and racking up the points!