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2018 Weekly Spread Commentary - Sample

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Here Comes Cold Weather!


Colder temperatures herald the last half of autumn and the approach of winter. What does that mean for the soy complex and for petroleum products?

Consider soybeans and soy products. The USDA reported that, as of November 4, about 83% of all US soybeans had been harvested. Thus, total supplies are at or near their annual peak. But after harvest passes its midpoint, producers normally try to withhold soybeans from the market and store as many as possible.

They wait both for the new tax year to arrive but more especially until prices can recover from their harvest lows.

Total supplies will now decline for the next 10-11 months. For the next few months, producers will sell only if/when they need to convert grain into cash (seed, fertilizer, loan repayments) or if prices are more attractive. Exports will soar through spring.

Domestic consumption also soars through winter because demand for soymeal --- a protein supplement for livestock feed --- is highest in cold temperatures. Soymeal has no commercially viable competitors, and livestock feeder cannot maintain large inventories because it can go rancid. Thus, for example, MRCI has found that May Soybean Meal has closed higher on December 27 than on about November 16 in 15 of the last 16 years.

Because soymeal normally accounts for 55-65% of product value, processors have great financial incentive to operate at capacity to meet that demand. In contrast, soyoil has many uses but almost many competitors --- the several raw crops of which are harvested at about the same time as soybeans. Thus, as surging demand for soymeal is being met, stocks of soyoil build almost as if it was byproduct.

Thus, even as soybean prices typically recover from harvest into the new year, soyoil prices tend to lag. In fact, the Long July Soybeans/Short July Soybean Oil spread has closed more favorably toward soybeans on about December 27 than on about November 16 in 15 of the last 16 years --- suffering significant or severe daily closing drawdowns in only 5 of those years and none whatsoever in 5. (Because these two contracts differ in size and pricing, MRCI calculates and plots spreads between them as the difference in their contract equity values, as expressed in US dollars. The value of a 1.00 cent/bushel move in soybeans is $50; the value of a 1.00 cent/pound move in soyoil is $600.)

Careful readers will note that this spread is almost a proxy for a long July soymeal position, although it will not always trade exactly as such. The spread itself has so far traded in a narrow range between its high last August at $29,403 (value of soybean contract greater than that of soyoil contract) and its low in September at 26,151. It has since worked slowly back toward its high, reaching 29,105 this past Friday.

What does this spread have to recommend it? Its low so far came in September --- one month earlier than its more typical October low. (Readers will remember that, according to cycle theory, an early bottom suggests a bullish environment.) Per the longer-term charts, the low made by the July 2018 spread (at 24,020) was an 8-year low. Does that suggest value --- especially compared to the July 2018 spread high of 34,848? Speaking of value and highs, these spreads of 2012, 2013, and 2014 all traded above 50,000 at one time or another before expiry.

Would a breakout above the August high of 29,403 not only confirm at least the short-term uptrend but also possibly trigger the seasonal uptrend that normally continues into the month of expiry? As long as the late October low at 26,895 holds, does this spread get the benefit of any doubt? Are Chinese tariffs already baked into price? Will cold weather now continue to help drive this spread higher?

Now consider gasoline and heating oil. These two petroleum products have nearly opposite patterns of consumption. When that for one is highest, that for the other is lowest. Indeed, during winter, consumption of heating oil is highest and that of gasoline is lowest.

But the industry and the market both know this and prepare for it. During autumn, when driving conditions worsen and schools resume, consumption of gasoline slows and its price can suffer. At the same time, temperatures cool, the industry builds inventories of heating oil, and price normally rises.

But normally by October/November, the product value of gasoline has reached its low and that for heating oil its high. Sufficient stocks of heating oil are already built even as refiners continue to operate at capacity. In fact, distributors begin aggressively to liquidate their inventories into the retail market.

The market has already priced gasoline for the lesser consumption of winter. But what about afterward? MRCI has found that March Gasoline has actually closed higher on about January 4 than on about November 20 in 14 of the last 17 years.

In other words, even before winter begins, the market has so undervalued gasoline and overvalued heating oil in order to encourage production of the latter that product values begin to look beyond winter --- and reverse. For example, the Long March Gasoline/Short March Heating Oil spread has closed more favorably toward gasoline on about January 3 than on about November 17 not only in 24 of the last 29 years but also in 17 of the last 18 --- albeit not without some large drawdowns. Each 1.00 cent/gallon is worth $420.)

This spread meandered quietly sideways/lower in a range of -20.00 to -25.00 cents/gallon from last March through September --- but then collapsed. In fact, the spread reached a new extreme discount just this past week at -52.94. In only 3 prior years have these spreads much exceeded a discount of -40.00! The spread has since bounced to -48.01 before ending the week at -50.62.

Can the market sustain that accelerated decline? Or was that the ultimate --- or penultimate --- washout? Yes, the spread is scary, with cold temperatures arriving before winter has even begun. And the potential for drawdown suggests this strategy may be best left to higher-risk, well-margined, experienced traders. But has the market already done its job?

If you have not already done so, you are encouraged to visit spread charts.

Please remember: These are NOT trading recommendations. They are intended only as potential ideas based on the market's own performance in the past, but past performance is not necessarily indicative of future results. Futures trading involves substantial risk of loss.

SEASONAL TENDENCIES ARE A COMPOSITE OF SOME OF THE MORE CONSISTENT COMMODITY FUTURES SEASONALS THAT HAVE OCCURRED OVER THE PAST 15 YEARS. THERE ARE USUALLY UNDERLYING FUNDAMENTAL CIRCUMSTANCES THAT OCCUR ANNUALLY THAT TEND TO CAUSE THE FUTURES MARKETS TO REACT IN A SIMILAR DIRECTIONAL MANNER DURING A CERTAIN CALENDAR PERIOD OF THE YEAR. EVEN IF A SEASONAL TENDENCY OCCURS IN THE FUTURE, IT MAY NOT RESULT IN A PROFITABLE TRANSACTION AS FEES AND THE TIMING OF THE ENTRY AND LIQUIDATION MAY IMPACT ON THE RESULTS. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT HAS IN THE PAST OR WILL IN THE FUTURE ACHIEVE PROFITS UTILIZING THESE STRATEGIES. NO REPRESENTATION IS BEING MADE THAT PRICE PATTERNS WILL RECUR IN THE FUTURE. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUEN TLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING RESULTS PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS. RESULTS NOT ADJUSTED FOR COMMISSION AND SLIPPAGE.


If you have any questions or comments, This e-mail address is being protected from spambots. You need JavaScript enabled to view it or call me at 541-525-0521.

Trade 'em
...
Jerry Toepke

P.S. MRCI provides even more spread research within our main service MRCI Online!
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Last Updated on Thursday, 15 November 2018 07:41  
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