Inter-Market Spreads: Current Trade Candidates

Jason Pearce

Jason Pearce

Jason Pearce is a 25+ year veteran of the futures markets. Since 1991, he has played the roles of retail broker and managing director of a brokerage firm, trader, market analyst, newsletter writer/editor and trading systems/algorithms developer. Jason is now actively managing money as an independent RIA.
Jason Pearce

Latest posts by Jason Pearce (see all)

by Jason Pearce

Trading At the Margins

Commodity markets can sometimes shoot to the moon or crash into the abyss. Price trends can also persist for years at a time. Yet, history shows that commodities are mean-reverting over the long run.

It’s somewhat intuitive that this would be the case. Supply and demand adjusts to accommodate the price. When price is at multi-year highs, producers ramp up production to take advantage of the profit margin. Buyers start backing off or, in some cases, find cheaper substitutes. Eventually the market gets saturated as a supply glut starts to build and prices plunge.

Conversely, low prices will squeeze and sometimes even eliminate the profit margin. This can cause some producers to start stockpiling supply instead of selling it. Or they may reduce production of that particular commodity and focus on something else. You see this happen when farmers switch which crops they plant because of the change in price. Then there are the producers that don’t have deep enough pockets to endure a prolonged period of operating in the red so they eventually get forced out of business. On the demand side, buyers may start to increase their buying to take advantage of the bargain prices and build their stockpiles when it’s feasible. This lessens supply over time and the commodity’s price eventually goes back up.

Even Better For the Spreader

Spreads between correlated markets tend to show an even stronger tendency of mean revision. This is why I’ve always focused more on the spreads than just the outright markets. When a spread between two highly-correlated markets hits price levels that it has rarely seen over the last couple of decades, we know it is on borrowed time. The probabilities favor a major reversal.

The persistence of regression to the mean is the whole reason why some of the best trading opportunities can materialize when commodity spreads are trading at the margins. At the very least, you should not have to worry too much about getting in and then getting stuck with ‘dead money’ where your position just drifts nowhere for months on end. The prevailing fundamentals have to maintain their momentum in order to justify the extreme prices, or else the move will run out of steam and the inevitable reversal starts.

To that end, there are some inter-market spreads currently trading at or near levels that are historically extreme. Some of them have already shown signs of a reversal and some are still trending as statistical outliers, but they are all worth monitoring. If you are a spread trader, you will want to keep close tabs on these potential trading candidates. Investigate how your trading methodology could be applied to take advantage of these situations extract profits from these opportunities.

Metals

Here’s the major theme in the metals sector: Either gold is just too darn expensive or else the rest of the metals (precious and industrial) are a screaming bargain down here. This is an anomaly that will eventually be corrected.

The good news is that, as a spread trader, you don’t have to guess which of these metal markets are priced correctly and which are not. You are simply betting on the return to normal in the relationship. If gold crashes while the other metals sit there, the spreads converge. If the other metals explode higher and catch up to gold, the spreads converge. There are actually five different scenarios of how the spreads can converge. Kinda like the old saying “Heads I win, tails you lose”. That’s a pretty good position to be in. Take a look at the charts and see for yourself.

The gold/silver spread tagged 80:1 at the end of August and began to retreat. As you can see on the monthly timeframe, the last couple of time the ratio reached 80:1 it quickly rolled over and began a major decline. If history were to repeat, the strategy would be to short gold and buy silver.

Gold Silver ratio monthly (nearest-futures)

Gold Silver ratio monthly (nearest-futures)

The ratio between 50,000 lbs of copper and 100 oz. of gold dropped just below 1:1. Over the last couple of decades, this has proven to be a temporary event and, therefore, a great buying opportunity. Be careful, though. You can see that the ratio has the potential to move substantially lower before recovering. The lows of the financial crisis prove this.

Copper (x2) Gold ratio monthly (nearest-futures)

Copper (x2) Gold ratio monthly (nearest-futures)

The platinum/gold spread inverted and hit a record low this year. The ratio hit the second-lowest level on record. We wrote a more in-depth post on this one earlier. It has been a favorite trade on the long side anytime you can buy the platinum under the gold.

Platinum Gold spread monthly (nearest-futures)

Platinum Gold spread monthly (nearest-futures)

Energies

The relationships between crude oil and its products have been in transition. The products reached historically unsustainable premiums over crude oil this summer and came crashing down. Rebounds could provide short sale opportunities. In addition, gasoline traded at a significant discount to ultra-low sulfur diesel fuel and it is now on the mend. Seasonal support kicks in soon, so buying a pullback in the gasoline/ULSD spread might be an appealing opportunity.

FYI: Until the spring of 2013, the ULSD was actually the heating oil contract. The only thing that changed is that the futures contract specs are now based on 15 PPM (sulfur content) rather than 2,000 PPM. This was done to comply with changes in the EPA rules that require lower sulfur content in distillate fuels. So don’t freak out about this being a new market. The ULSD is strongly correlated to heating oil so the historic price data should still serve as a good guideline for price boundaries.

Anytime the ULSD/crude oil ratio has hit 1.45:1 or higher, it has eventually petered out and then dropped back under 1.2:1. It appears to have peaked out months ago. However, there may still be plenty of downside ahead. Selling rallies in this spread could be the way to go.

ULSD Crude Oil ratio monthly (nearest-futures)

ULSD Crude Oil ratio monthly (nearest-futures)

The RBOB gasoline/ULSD (formerly heating oil) spread tends to be a good candidate on the long side once the ratio between these two markets drops to 0.85:1 or lower. The March 2016 ratio was already this low a couple of months ago. The spread is already in an uptrend and seasonal patterns will start to reinforce the rally this month. Take any pullback as an early gift from Santa!

RBOB Gasoline ULSD ratio monthly (nearest-futures)

RBOB Gasoline ULSD ratio monthly (nearest-futures)

Livestock

After the historic 2012 drought spurred a significant liquidation in the US cattle herd, the beef market turned into a raging bull as prices rocketed higher for a couple of years. Since then, price has been on the defensive.

The big run-up pushed livestock spreads and livestock/feed spreads to record highs as well. Although the spreads are now working their way lower, history suggests there’s still a long, long way to go on the downside. Spread traders should be watching for short sale opportunities.

Both the ratio and the spread between feeders and live cattle topped at record highs last year and have been on a south-bound train since then. It’s still quite a ways off until the median level is hit. This could be a spread worth shorting on the rallies.

Feeders Live Cattle ratio monthly (nearest-futures)

Feeders Live Cattle ratio monthly (nearest-futures)

Judging by the current live cattle/lean hog ratio, beef is way too expense. Or is the pork too cheap? Could be both. Historically, the live cattle/lean hog spread has been a short sale candidate whenever the ratio was above 2:1. It’s above there now. Look for a setup to get short.

Live Cattle Lean Hog ratio monthly (nearest-futures)

Live Cattle Lean Hog ratio monthly (nearest-futures)

Livestock & Feed

More than half of the production cost in the livestock business is feed. Corn is the most popular feed for the animals. Therefore, it only makes sense to trade the spread between livestock and feed costs.

The stampede to record highs in feeder cattle, combined with bumper corn crops, caused the spread between feeders and corn to reach record highs by the end of 2014. This created a huge profit margin and encouraged more beef production. Since then, the feeder/corn spread has been working its way lower. As you can see on the long-term chart, the current bear market is still at historically high levels. This could keep the downward trajectory intact. Selling rallies may continue to be what the smart traders are doing.

The feeder/corn ratio made a record-shattering high of nearly 7.5:1 last year. It has been working its way lower since, but the long-term charts show that a drop below 3:1 from here is still quite a reasonable expectation.

Feeders Corn ratio monthly (nearest-futures)

Feeders Corn ratio monthly (nearest-futures)

In comparison to the cows, it’s the pigs that are really getting slaughtered. It’s not quite there yet, but the current trend could push the value of a lean hog contract below the value of a corn contract. If that happens, it could quickly turn into a great buying opportunity. Keep this one on the back burner for now, but move it to the front burner when you can buy 40,000 lbs of hogs for less than the cost of 5,000 bushels of corn. The hog/corn spread may not sound very sexy, but it’s been a reliable money-maker for us in the past.

Lean Hog Corn ratio monthly (nearest-futures)

Lean Hog Corn ratio monthly (nearest-futures)

Grains

Somebody better call Dr. Phil because the relationship between the byproducts of a crushed soybean (meal and oil) is historically out of whack and the relationship between Kansas City and Chicago wheat is completely upside down. History suggests that there will be reconciliation, even without therapy.

The soy meal/bean oil spread appears to have formed an epic double top between the 1973 historic high and last year’s new record high. Previous excursions to the upper price boundaries have been followed by meal completely surrendering its entire premium over the meal. The spread still has several thousands of dollars of downside ahead of it if history is to repeat.

Soy Meal Bean Oil spread monthly (nearest-futures)

Soy Meal Bean Oil spread monthly (nearest-futures)

The Kansas City wheat/Chicago wheat spread pops up on our radar screen anytime the KC wheat trades at a discount to the CBOT wheat. The recent plunge to -40 cents (premium CBOT wheat) really has our attention since it’s at a low we’ve only seen three other times in the last forty-five years. This rubber band is really stretched. Being long for the snapback could be something worth getting positioned for.

KC Wheat CBOT wheat spread monthly (nearest-futures)

KC Wheat CBOT wheat spread monthly (nearest-futures)

Softs

The price difference between good coffee (Arabica) and the ‘cheap stuff’ (Robusta) continues to shrink. At a certain point, coffee roasters may take advantage of the narrowing price difference by adjusting their blends to use more of the Arabica coffee. Or maybe the consumers will figure out that Robusta is over-priced on a comparative basis and consume more of the Arabica drinks. Regardless of how it plays out, something will happen to reverse the narrowing price gap when it gets tight enough. This coffee spread is not too far away from where prior reversals have materialized. If the ratio between the value of one Arabica coffee contract and one Robusta coffee contract drops below 2.4:1 it will be time to start stalking the java spread.

Arabica Robusta ratio weekly (nearest-futures)

Arabica Robusta ratio weekly (nearest-futures)

In the Hunt

I was sitting in the trading room of a well-respected trader several years ago, and he had a sign on the wall that caught my attention. It read: A good hunter never chases. He waits. Boy, does that sure have everything to do with trading!

The spreads that we discussed are the big game right now. They offer some great potential profit opportunities. Continue to stalk them, but wait until you have an actual trade setup before pulling the trigger and entering a position. No cross-hairs, no shot. No setup, no trade. Be patient and wait for the clean shot, lest you waste your bullets and, more importantly, your capital.

Seasonal Synergy for the Soybean/Wheat Spread Setup

Jason Pearce

Jason Pearce

Jason Pearce is a 25+ year veteran of the futures markets. Since 1991, he has played the roles of retail broker and managing director of a brokerage firm, trader, market analyst, newsletter writer/editor and trading systems/algorithms developer. Jason is now actively managing money as an independent RIA.
Jason Pearce

Latest posts by Jason Pearce (see all)

By Jason Pearce

Did the Fall Finish in Autumn?

Decent autumn harvest weather and large US crops caused soybeans, corn, and wheat to drop from their summer peaks into new contract lows for 2015. In the case of beans and wheat, the futures markets traded to their lowest prices in several years.

Now that the dust has settled, the grain markets have somewhat stabilized. For the most part, they have been confined to trading ranges for the last few weeks. Perhaps the barn-busting 2015 crops are now factored into the market prices. There’s reason to believe that things could start moving again soon, though.

Gearing Up For Action

The wheat market may be the one to start moving as new fundamentals develop. The reason is because wheat actually gets planted twice a year in the US. The spring wheat crop was just harvested. Now US farmers are planting the winter wheat crop. This is the crop that will be harvested next the spring.

Not only does the new crop plantings mean that wheat could start trending again, but it also means that inter-market grain spreads could see some increased trading activity as well. This may provide informed traders with an opportunity in the soybean/wheat spread. If you are not familiar with this one, read on.

Birds of a Feather

Despite the fact that beans have only one crop per year in the US and wheat has two crops, the price trends in the two markets are highly correlated. This is not a new development, either. One can look at nearly half a century of monthly closing prices and see that beans and wheat often peak and bottom at or near the same time.

Soybean Wheat overlay (nearest-futures) monthly

Soybean Wheat overlay (nearest-futures) monthly

Of course, there are exceptions to this observation. But the exceptions have always proven temporary. This means two things: First, the strong correlation between soybeans and wheat makes it a tradable spread relationship. Second, the divergence in the price trends between the two markets is likely to be a temporary event and, therefore, an opportunity to get positioned for a bet on the return to the historic correlation.

Historical Spread and Ratio Levels

One way to identify a trading opportunity in a spread is to locate price levels that have historically been extreme events. By that we mean prices that the spread rarely makes it to and prices that have been unsustainable for prolonged periods of time.

Soybean Wheat spread (nearest-futures) monthly

Soybean Wheat spread (nearest-futures) monthly

In terms of the price difference between beans and wheat, $6.00 (premium beans) appears to be the outlier on the high side and $1.50 (premium beans) appears to be where the rubber band is stretched too far on the low side. Whenever the spread has gone to or beyond these price levels in the past, there has ultimately been a reversal.

Over the last few years, though, we’ve seen the soybean/wheat spread clear six dollars several times. It even hit a new record high in 2013. Part of the reason for this is because the grain markets themselves posted historic highs. When that happens, the spreads reach record highs as well. The record prices can distort the extremes in the relative value between markets. To remedy this, viewing the ratio between the beans and wheat can clarify whether or not the market relationship is historically out of whack.

Soybean Wheat ratio (nearest-futures) monthly

Soybean Wheat ratio (nearest-futures) monthly

The 30,000 foot view of the bean/wheat ratio shows that the beans are unsustainably overvalued when the ratio reaches 2.4:1 or higher. Whenever this level has been reached or surpassed, the ratio would ultimately reverse. Conversely, the bean/wheat ratio is undervalued whenever it has dropped below 1.4:1. Prior excursions to this level or lower have all been followed by a major recovery where beans outperformed wheat for months and even years afterwards.

The Value of Seasonal Patterns

The nearest-futures soybean/wheat spread is currently around $3.62 (premium beans). Historically, this is no man’s land. The spread would have to move over two dollars from here in either direction in order to start probing the historical boundaries where a trend reversal setup becomes more favorable.

Furthermore, the current bean/wheat ratio is at 1.7:1. This is uninspiring to the spread trader who scouts out levels in the relationship between beans and wheat where the difference has experienced enough of a divergence to trigger crop rotation, relative value plays, or something fundamental that would act as a catalyst for an eventual reversal.

The absence of an outlier in current price levels does not mean that the hunt for opportunity is off, however. We still have another weapon in our trading arsenal that could serve us well: the seasonal pattern.

A seasonal pattern shows the typical route that a market or a spread follows during the year. This makes perfect sense. After all, we know that grains will be planted in the spring and harvested in the fall every year. And it’s no secret that refiners will switch from producing heating oil to producing gasoline as they anticipate the warming temperatures and the start of the US driving season. Therefore, we have a pretty good idea of what the supply and demand trends for various commodities should be at certain times of the year.

The seasonal pattern is not the Holy Grail of trading. Nothing works all the time in every market. But knowing the seasonal patterns can still give you a very tradable edge. Some markets are more compliant with their seasonal patterns than others, so you really want to pay attention when you find one with a consistent track record. Those should be your weapons of choice. In the case of the soybean/wheat spread, the seasonal pattern might just be the silver bullet that compels us into taking the shot.

Remember, Remember the Fifth of November

Now that the 2015 harvest is over and planting for the 2016 winter wheat crop is in progress, the spring 2016 bean/wheat spread is in our crosshairs. Seasonally, you will be looking to buy the spread this week and sit on it for about two months.

Moore Research Center, Inc. has already done the work on this trade. According to their research, you should buy the May 2016 soybean contract and simultaneously sell the May 2016 wheat contract on November 5th and exit the spread on January 8th. I repeat: Buy the spread on Guy Fawkes Day and hold it through the first full week of the new year.

This seasonal spread trade has worked every single year since 2000. For the mathematically challenged, that’s fifteen consecutive years of winners. Will it work for the sixteenth year in a row? We don’t know. The future is not guaranteed, especially when trading futures. But would you want to bet against something that has worked for a decade and a half straight?! There’s a sign on the wall of a local Irish pub that says, “The race does not always belong to the swiftest nor the battle to the mightiest, but that’s certainly the way to bet”. There’s wisdom in those words. Always bet with the odds.

In addition to the success rate, the payout on the seasonal May soybean/wheat spread has been a respectable +$2,042 in profits (on average). On a 5,000 bushel-per-contract spread, this represents a gain of nearly 41-cents. Since the 2015 price range for the May 2016 bean/wheat spread has been $1.11 so far, 41-cents represents just over one-third of the year’s entire range to date. That’s not an insignificant move.

Technical Outlook

The plot thickens as the chart pattern on the May 2016 bean/wheat spread indicates that price support may have been established. Technically, this lays the foundation for a move higher.

Depending on how picky you are, one could say that a double bottom-type pattern was established on the daily chart between the December 17, 2014 low of $3.59 1/2 and the September 23, 2015 low of $3.56.

If the three and a half cent difference between the two lows bothers you, we could alternately refer to it as a Wash & Rinse pattern. This occurs when a market undercuts an important price low, sees little or no follow-through, and then quickly reverses higher. The mechanics are such that any sell stops or algorithm sell patterns below the price bottom are initially triggered on the break. The lack of a continued decline indicates that the sellers were suckered in, subsequently forcing them to start buying on the recovery. This is considered a bear trap, which is a bullish pattern.

May 2016 Soybean Wheat spread daily

May 2016 Soybean Wheat spread daily

Furthermore, the May 2016 bean/wheat spread has not been able to close below $3.70 for more than four consecutive sessions. This indicates that demand keeps coming in down around this current level. As a buyer, you want to locate the levels where demand has been consistent and take advantage of it. One you identify this area, you know where to buy. You will also be able to monitor the level for any important changes in the behavior pattern.

Balancing the Probable with the Possible

We discussed the setup and entry/exit parameters for the May 2016 soybean/wheat spread trade. It’s a no-brainer that you want to find seasonal trades with a long track record of success. This indicates that there are strong and consistent underlying fundamentals that drive the spread. It means the odds of bagging a winner on the next go-around are favorable. That’s what trading with the probabilities is all about.

However, your trading plan is not complete until your addressed the possibilities. This is where risk management comes in. You have to determine your position size (how many contracts) before you take the trade. Make sure it is small enough to withstand the inevitable losing streaks that come with the territory. Risk management is the Yin to the Yang of trade selection. Just like the ancient Chinese philosophy, it is complementary to trade selection, not opposed to it.

In the event that the May 2016 bean/wheat spread breaks the current contract low of $3.56, it’s probably time to go on the defensive. Where do you throw in the towel? Will it be on a 10% break of the contract low at $3.20? Will it be on a two or three-day close below the September low? Will you take a close below the September low as a sell signal with a close back above it as a reentry signal? If so, how many trades in a row like this will you take before you have endured enough whipsaw and call it a day? Take inventory of your trading capital, confidence levels, and emotional makeup to determine the answers to these questions. Then get ready to pull the trigger and buy the May bean/wheat spread.

By the way, some of the best research that you can ever find on commodity spreads can be found at MRCI.com.

Sugar: The Emerging Bull Market

Jason Pearce

Jason Pearce

Jason Pearce is a 25+ year veteran of the futures markets. Since 1991, he has played the roles of retail broker and managing director of a brokerage firm, trader, market analyst, newsletter writer/editor and trading systems/algorithms developer. Jason is now actively managing money as an independent RIA.
Jason Pearce

Latest posts by Jason Pearce (see all)

by Jason Pearce

Goodbye, Mr. Sugar Bear Sugar Bear

Sugar has been in a bear market for so long that it only seems to move in two directions: down and down some more! However, no trend lasts forever. This certainly does not mean that we should forget the words of Keynes who said, “The market can remain irrational longer than you can remain solvent”. But the fact of the matter is that changes in supply and demand will cause a trend to eventually reach its conclusion over time. Since markets have a habit of overshooting their equilibrium price, the end of one trend is often followed by a new trend in the opposite direction. If nothing else, a sharp retracement should occur as trend followers unwind their positions when the ride is over.

Looking at a combination of market fundamentals, price action (the ‘technicals’), and seasonal patterns, it is quite possible that the recent two-month increase in sugar prices is more than just another bear market rally. This could potentially be the start of a new bull market. Based on the history of this commodity, it may have a lot further to run. If so, traders had better pay attention.

The Global Glut

After peaking at a thirty-year high on Groundhog’s Day of 2011, the bull market saw its shadow and retreated. As it turns out, this was the start of what would turn into a multi-year bear market.

Fundamentally, the bear market was driven by a global supply glut that hammered sugar prices as supplies exceeded demand for five years straight. This was due to a combination of big crops coming out of Brazil (the world’s largest sugar exporter) and slowing demand in China (the world’s largest sugar importer).

Furthermore, the Brazilian real has been in a multi-year bear market as it shed nearly two-thirds of its value from the 2011 peak to last month’s record low. This kept their sugar exports streaming along as it negated any incentive for Brazil to hold anything back from the marketplace.

It looks as though there may finally be light at the end of this bearish tunnel, though. Excess rains hampered the Brazilian harvest and now dry weather is posing a risk to the next Brazilian crop. For the new season that starts this month, the International Sugar Organization is forecasting that demand will finally exceed production for the first time in years. This trend is expected to continue with the size of the gap between supply and demand more than doubling the following year.

As a further threat to supply, El Nino has returned and it is projected to be one of the strongest since record keeping began in 1950. This weather pattern has the potential to wreak havoc on crops all around the globe, including sugar. If you’ve ever seen or traded a weather market in commodities (think drought in the grain and livestock markets or freezes in the coffee and orange juice markets) then you know that the sky is the limit for how high the prices can go.

Bear Market Duration

This bear market has been a doozy. It is one for the record books. Although markets can and sometimes do break records, commodities are statistically mean-reverting. In other words, the trend will eventually end and the market will give back the lion’s share of its move. It’s similar to a pendulum. The more extreme the market moves in one direction (in price or time), the more likely it is to reverse and swing significantly in the opposite direction.

The nearest-futures sugar closed at a price of 14.52 in 2014 and posted an annual loss of nearly –12%. This follows a –27% annual loss in 2011, a –16% annual loss in 2012, and another –16% annual loss in 2013. This four-year duration of consecutive losses marks the longest string of annual losers that sugar has experienced in the last half century.

From high to low, this bear market in sugar lasted a duration of 4 years, 6 months, and 22 days. This is the second-longest bear market in sugar since 1969 and it falls less than a month shy of matching the record 4-year, 7-month, and 15-day decline from the 1974 record high to the 1978 low. The $64,000 question now is whether or not the “sugar bears” will be like the Chicago Bears this year and match their longest losing streak in franchise history!

Size Matters

In addition to the duration of this bear market, the size of the decline is also significant. Basis the nearest-futures, sugar declined a whopping -72% from the 2011 bull market peak to the seven-year low that was posted in August. This is the largest sugar bear market in sixteen years. This size of the decline was just one percentage point shy of matching the -73% bear market decline into the 1999 low, which ranks as the third-largest bear market in nearly half a century.

Sugar Monthly (nearest-futures)

Sugar Monthly (nearest-futures)

In the interest of full disclosure, the top two bear markets were downright cataclysmic. Sugar suffered a -91% meltdown during the 1974-1978 bear market and it endured a record -94% decline during the 1980-1985 bear market. This does not negate the severity of the recent bear market, but it does show that Keynes remarks apply to commodities as well.

Given the historic extremes in terms of both the duration and the size of the recent bear market in sugar, it only makes sense that we should expect the pendulum to eventually swing hard in the other direction. It is possible that the swing has now started.

The Upside Potential

Let’s say that the multi-year bear market reached its conclusion in August. Furthermore, we’ll also assume that sugar has started a new bull market. If so, what sort of expectations should we have for future prices?

While we don’t know what the future holds, we can go back to the past and see how the market behaved before. By examining prior bull markets that followed bear markets, perhaps we can get a feel for the upside potential in sugar.

Trading this market is not for the faint of heart. Sugar tends to make sizable moves. This is a good thing! You can’t make big money in a market that doesn’t move much.

Following the last four bear markets in sugar, the new bull markets experienced gains of +166%, +304%, +263%, and +177% from the final lows. Just matching the minimum +166% gain from the current low would put sugar at 27 cents. That’s nearly double the current price. If you knew in advance that a commodity market was set to potentially double from current levels, wouldn’t you try to capitalize on it?

In the event that sugar matches the median-size bull market gain of +220% or an average bull market gain of +228% (based on the last four bull markets), it would be on a trajectory toward either side of the 2011 multi-decade high near 36 cents. If the pendulum analogy holds sway, the new bull market could go even further than that.

I will emphasize, however, that sugar is not morally obligated or legally bound to repeat its past behavior. It could do something totally different this time. Analyzing the past simply allows us to determine the probabilities. There are not certainties in the business of speculation. But knowing the probabilities is quite valuable. In the land of the blind, the man with one eye is king.

Sweet Seasonal Patterns

When you look at the last four decades of sugar prices, a seasonal pattern emerges. From a macro view, it appears that sugar tends to hit bottom towards the end of September. It then has an overall bullish trajectory until late January. If so, we are currently only one-quarter of the way through this bullish timeframe. Buying dips over the next couple of months could be the trading strategy to use.

Sugar Seasonal Pattern

Sugar Seasonal Pattern

Dialing it in a little closer, it appears that sugar has a seasonal tendency to make a pullback into mid-November and another dip in mid-December. If so, traders should be watching for this pattern to materialize over the coming weeks. It could offer a great setup to either establish a long position or add on to one.

The Technical Outlook for Sugar

Recent price action may confirm the suspected trend change. In the interest of keeping things simple, let’s take a look at just one sugar chart. After all, Occam’s razor theorizes that the simplest answer is usually the most accurate one. He probably would have been a great trading system developer.

Looking at the sugar ETF (symbol:SGG), we see that September ended with the first end of week close above the weekly 20-bar Moving Average since June of 2014. This triggered a bullish trend change.

In itself, there is nothing inherently magical about the weekly 20-bar MA. It is merely a reference point. The reason that we reference it, however, it because of what happened the last three times that SGG bounced into the declining weekly 20-bar MA. In January, May, and July this sugar ETF rallied up to a multi-week high and traded either side of the declining weekly 20-bar MA. By the end of the week, SGG had backed off and closed the week out with a loss. New multi-year lows were seen shortly thereafter.

This time around, SGG traded within striking distance of the weekly 20-bar MA in mid-September, backed off for a week and a half, and then blasted its way to new multi-week highs at the end of the month. For good measure, the ETF continued its “sugar spike” into this month. This changed the bearish pattern of bouncing and then rolling over at the weekly 20-bar MA.

SGG (Sugar ETF) Weekly (20-bar MA)

SGG (Sugar ETF) Weekly (20-bar MA)

Now that this technical resistance barrier has been broken, it becomes a support level. At this point, a pullback to the weekly 20-bar MA might offer a low risk entry point on the long side of SGG. It may be even more lucrative if were to occur in mid-November when a temporary seasonal pullback is due.

Another simple observation is that the price structure itself turned bullish. SGG pulled back to a higher low in mid-September and then rallied to a higher high in late September. By definition, a higher low and a higher high indicates that sugar is currently in an uptrend. Until this pattern changes, you want to be on the long side of this market.

Details, Details

The case for a new bull market in sugar has been presented. The synergy of historic extremes reached in a mean-reverting commodity, followed by rapidly changing fundamentals in a bullish seasonal time window, and recent price action signaling a trend change are quite compelling. Now that you have been enlightened, you still have to know what to do with this knowledge.

There’s an old saying that “the Devil is in the details”. There’s an even older saying that “God is in the details”. Perhaps the difference between the two is the outcome. Making a forecast for the sugar market is one thing, but trading it is another matter. To trade successfully, you must have a detailed plan of where to get in, how much to buy, where to add to positions, and where to get out.

There are several ways to skin this trading cat. There is no absolute right or wrong answer, although there are some widely-accepted principles (trade with the trend, let the profits run, cut losses short, don’t add to losing positions, etc.) that serve as guidelines. Every trading must find the methodology that best suits their personality and temperament. You must roll up your sleeves and do the hard work. Figure out how your trading methodologies and systems will apply to the current opportunity in sugar. If you don’t currently have a detailed trading plan, find a mentor who can help you create one. It’s going to take plenty of effort on your part, but the rewards are well worth it. Good luck in the Sugar Bull!

Commodity Market Update with Andy Hecht

Natural Gas: It’s Go Time

Summary

History says Buy.

This energy commodity was the first to yack.

The King is dead, long live the new King.

All the bearish news is in the price.

A historically volatile market — watch out.

Last Monday, when all hell was breaking loose in markets around the world and crude oil plunged to the lowest level in over six and a half years at $37.75 per barrel, natural gas really tried to follow. The price got down to $2.641 per mmbtu and no one would have been surprised if it traded below support on the weekly chart at $2.4430, the April 2015 continuous contract lows. Support on the active month NYMEX October futures contract at $2.6380 even held, and the energy commodity stayed within the trading range. By Friday, as oil recovered in violent fashion to close a volatile week almost 20% higher than the lows on Monday, natural gas quietly closed at $2.724 per mmbtu.