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By Jason Pearce

Has the Wheat Crop Flip-Flop Stopped?

Van Gogh Wheat Field

About a month ago, we posted a watch list of various inter-market spreads that offered trading opportunities. It was based on the criteria that the spreads between several correlated markets had reached price boundaries that were historically extreme. Some of the spreads had already rolled over and were fair game; some were still trending in outlier territory and should be closely monitored. All of them had a history of making sizable reversals.

In the grain sector, the relationship between Kansas City and Chicago wheat caught our attention. The price of the KC wheat dropped below the price of Chicago wheat back in late June. This set things in motion for a buying opportunity. You know the old disclaimer that’s going to be inserted right here: Past Performance Is Not a Guarantee of Future Results. However, good trading is about probabilities, not prediction. Therefore, I would submit to you that Past Performance Can Tell You Something About the Probabilities of the Future.

History shows that anytime the price spread between Kansas City wheat and Chicago wheat inverted it has always been followed by a recovery. So we’ve been keeping an eye on this spread since the inversion. Recent price action suggests that a recovery from the summer price flip-flop could finally be underway. This may be the green light we needed for spread traders to get positioned on the long side.

Paying For Quality

The price difference between the wheat contracts in Kansas City and Chicago is not due to the location of the exchanges, it is based on the differences in the types of wheat for the underlying futures contracts. The Kansas City wheat contract is for hard red winter wheat and the Chicago wheat contract is for soft red winter wheat. The protein content of hard wheat is higher than that of the soft wheat. It is considered to be of a higher quality, so it normally trades at a higher price.

Although we are looking at two different types of wheat here, the price correlation between these two crops is extremely high. When you superimpose the price charts of Kansas City over the Chicago wheat, you’d be hard-pressed to spot the difference between the two. This high correlation between the two markets makes for a ‘safer’ spread trading candidate. ‘Safer’ is a relative term, though. When you are dealing with leveraged futures contracts, there’s always risk involved. But risk management and strong correlations in spread relationships help to mitigate the risks.

Kansas City Wheat Chicago Wheat overlay (nearest-futures) weekly

Kansas City Wheat Chicago Wheat overlay (nearest-futures) weekly

Despite the higher quality, the price premium of the Kansas City wheat over the Chicago wheat is not a locked in guarantee. This is because there can occasionally be changes in the supply and/or demand of one of the crops that does not impact the other crop as much. So one of the contracts may rise or fall faster than the other. This has been the case for this year.

The Inversion of 2015

Ample supplies around the globe and multi-year highs in the US dollar have weighed heavily on the entire wheat market this year. This was merely a continuation of the multi-year bear market across the entire grain sector. However, there was a temporary run-up this summer when the soft wheat growing region was hammered by a deluge of rain. This occurred just before right before the harvest as the seeded area was already below the five-year average.

The price decline continued when the second half of the year started and Kansas City wheat moved down at a faster rate than the Chicago wheat. Ergo, the spread price inversion. The government resumed their projections for global grain supplies to reach new all-time highs before the next North American harvest. This week’s new multi-year high in the US dollar only serves to reinforce the bearish outlook.

Vulnerable Shorts

Despite all the gloomy news about abundant grain stocks and the strong greenback, the wheat market may be vulnerable to a rally right now. According to the recent weekly Commitments of Traders report, speculators have increased the size of their net short position in the Kansas City wheat rose for six consecutive weeks. This is the longest such bearish streak in four years. Furthermore, the size of the net short position is the largest in nearly a decade.

These short positions are speculators that we are talking about. They don’t actually have the physical wheat to deliver against the contracts that were sold short. Should any of the CTAs or hedge funds decide to do some short-covering as we approach year end, it could result in a sharp rally that triggers program-buying (buy stop orders) by other speculators. This may have a domino-effect and continue pushing prices higher as more and more buy orders are triggered by higher prices. The KC/Chicago wheat spread would likely soar on the turnaround. Any bullish change in the underlying fundamental picture would only add fuel to the fire.

Know the Boundaries

Just like in healthy human relationships, it’s important to know where the boundaries are at in spread relationships. When boundaries are tested or crossed, the balance of things will be upset. Something big will happen. In spreads, this usually means that a reversal is inevitable.

Kansas City Wheat Chicago Wheat ratio 1.2 (nearest-futures) weekly

Kansas City Wheat Chicago Wheat ratio 1.2 (nearest-futures) weekly

At normal levels, Kansas City wheat should have a price premium either side of 10% over Chicago wheat. When that premium climbs to 20% or more, then it’s time to pay attention. The KC wheat has only reached a premium of 20% or more over the CBOT wheat about half a dozen times in the last four decades and it never lasted. Therefore, if you even see a +20% markup on the KC wheat you know that the KC/Chicago wheat spread is a prime candidate for a short sale.

Conversely, when the Kansas City wheat loses its premium over the Chicago wheat it’s a warning shot for traders. In the event that the Chicago wheat reaches a premium of 5% or more over the Kansas City wheat, it’s time to get your game plan (and your capital) together for an opportunity on the long side of the spread.

Kansas City Wheat Chicago Wheat ratio 0.95 (nearest-futures) weekly

Kansas City Wheat Chicago Wheat ratio 0.95 (nearest-futures) weekly

For Chicago wheat to surpass a 5% premium over Kansas City wheat, the KC/Chicago wheat ratio has to drop to 0.95:1. The ratio has only been this low two times in the last ten years and not even a dozen times in the last four decades. The inversion was always temporary. Inevitably, things would play out and Kansas City wheat would go back to have the normal 10% premium (or more) over Chicago wheat. In spread terms, KC wheat would get back up to a 35 to 40 cent premium over Chicago wheat.

Darkest Before the Dawn

In late June, the nearest-futures KC wheat closed below the price of the CBOT wheat. This was the first spread price inversion in three years so we immediately put it on the watch list. The spread rebounded in the second half of July, but it was never able to get back above the ‘even money’ mark. It just settled into a trading range for the rest of the summer.

Kansas City Wheat Chicago Wheat spread (nearest-futures) weekly

Kansas City Wheat Chicago Wheat spread (nearest-futures) weekly

A month ago, the nearest-futures December KC/CBOT wheat spread left the trading range and plunged to a new eight-year low of -40 1/4 cents (premium Chicago) on the daily timeframe and -33 cents (premium Chicago) on the weekly timeframe. The spread has only been this upside down on three other occasions since 1970. This is a big deal. The more infrequent that the price levels have been hit, the more potential the spread has for a major move. By all accounts, there was nothing to stop the KC/CBOT wheat spread from sinking to the September 2007 capitulation low of -61 1/2 cents (premium Chicago). The relationship was coming under fire.

Turning On a Dime

Despite the new multi-year lows in early November, the spread has since made quite a turnaround. More impressively, this occurred in the face of new contract lows in both the Kansas City wheat and the Chicago wheat just this week. It is quite possible that the spread has finally bottomed out.

Further evidence of a turnaround is the behavior of the spread itself. First of all, the March KC/Chicago wheat spread ended the month with a close above the declining 75-day Moving Average for the first time in six months.

March Kansas City Wheat Chicago Wheat spread daily

March Kansas City Wheat Chicago Wheat spread daily

In addition, the spread has rallied nearly 25-cents from the November 5th contract low. This is the biggest rally in fourteen months. It is also the longest rally since the bounce off the December 2014 low. This ‘overbalancing of price and time’ is indicative of a trend change. Based on history, the KC/Chicago wheat spread may now be on its way toward +40 to +50 cents (premium Kansas City).

Outside Confirmation (Just In Case You Need It)

Coincidentally, Societe Generale is on the same page as us. Although they recently lowered their average price forecasts for several ag markets, the bank actually raised their price expectations for soft red winter wheat. Moreover, they stated that they expect the Kansas City wheat to go back to trading at a premium of 7-10% over the Chicago wheat in the first quarter of 2016. Perhaps the analysts are students of history. Perhaps they read our research.

What to Do Now

It’s time to get long. Simply put, spread traders should be buying Kansas City wheat contracts and shorting the Chicago wheat contracts.

For entry points, you might want to consider buying a pullback of 8-10 cents. This idea is based on the current price structure: During the multi-month decline off the May top, the March KC/Chicago wheat spread made several bounces of ten cents or more. During the recent one-month rally, the spread has made a pullback of six and a half cents and another pullback of nine cents. Therefore, countertrend moves of 8-10 cents appear to be good entry opportunities.

Seasonally, the KC/Chicago wheat spread has a tendency to soften in the second half of December. Buyers can use this to their advantage by scaling into a position if the pullback materializes.

March Kansas City Wheat Chicago Wheat spread (even money line) daily

March Kansas City Wheat Chicago Wheat spread (even money line) daily

The November 5th contract low of -26 cents (premium Chicago) is an important line in the sand for the March KC/Chicago wheat spread. A close below this price would indicate that the recovery is in jeopardy. Therefore, it would be prudent to use such an event as a liquidation signal for long positions. Take the hit, get to the sidelines, and wait for a recovery signal before you reenter.

Even if the KC/Chicago wheat spread plunges to new lows before the year is out, it should eventually rebound. Unfortunately, we don’t have a crystal ball that tells us how low it will go first before that happens. Every record low price in history was made when the previous record low was broken. You don’t want to be held hostage in a long position during those sorts of events. Cut your losses if the spread between the hard red wheat and the soft red wheat dips into the red. You can make it all back once it’s in the black.

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by Andrew Hecht

Report for the Opening of markets on December 7, 2015


Last week we saw three major events that affected markets across all asset classes. On Wednesday, a tragic terrorist attack in San Bernardino, California is yet another reminder of the dangerous world in which we live. On Thursday, the ECB surprised markets by not delivering the level of stimulus expected and the U.S. dollar fell. The dollar index made a new high at 100.60 and then proceeded to fall over 2600 points on the session. The dollar put in a bearish key-reversal trading pattern on both the daily and weekly chart.

On Friday, the jobs report supplied another data point in support of an interest rate hike by the U.S. Federal Reserve later this month. OPEC met in Vienna last Friday and the result of the meeting could be a free for all of selling in oil from members. in a surprise move, OPEC adopted a “wait and see” policy in terms of the low level of oil prices while at the same time the cartel unofficially raised their production ceiling to 31.5 million barrels per day.


Precious Metals – Both gold and silver made new multiyear lows last week as they fell to $1045.40 and $13.805 respectively before the correction in the dollar caused a rally in both precious metals. February COMEX finished up on the week at $1085.80 level and silver moved up to $14.545 per ounce. Meanwhile, platinum group metals also moved higher on the week. Platinum fell new lows at $825 but closed the week at $880.40 per ounce. Palladium traded down to under $523 but closed the week at $566.60 per ounce.

Divergences continue in precious metals. The silver-gold ratio is around 74.4:1, which is continues to be a bearish signal for the sector. The platinum-gold spread closed at $203.50 — platinum under gold.

The action in precious metals markets will be interesting in the sessions ahead. It is possible that gold will follow through to the upside after the bullish technical action last week. Watch the inter-commodity spreads between precious metals.

If the silver-gold ration and platinum gold spread move lower, it could mean that we will see a sustained recovery rally. However, I would look at any price recovery as another selling opportunity as the fundamentals for the U.S. dollar remain bullish for the medium-term.

Energy – Crude oil closed the week below the $40 level on the active month NYMEX January futures contract at $39.97 per barrel. Processing spreads weakened slightly in heating oil but continued to strengthen in gasoline. Term structure in crude oil widened with contango on the January 2016 versus January 2017 spread in WTI making a new high at the $7.77 level.

Brent spreads in the same months also widened. Widening contango is yet another bearish signal for the energy commodity. The Brent premium over NYMEX crude moved marginally higher to $3.03 premium for Brent over WTI level. The move higher is likely due to fears surrounding Middle Eastern crude flows in the wake of increasing terrorist attacks.

Crude oil fundamentals and technicals are bearish but the political premium on crude remains low considering that over half the world’s reserves are located in the Middle East.

Natural gas made new contract lows on January futures contract at $2.131before recovering and closing last Friday at the $2.1840 level as the market prepares for winter. We saw the first inventory withdrawal of the season last week and stockpiles fell below 4 trillion cubic feet.

There are enough natural gas stockpiles at this point to deal with whatever Mother Nature throws at the United States this winter, which will likely continue to add bearish fuel to the natural gas futures market. Natural gas open interest rose slightly which could be a sign that some shorts are returning to the market.

The contango remains high with February futures trading at a 6.1 cent premium to January futures reflecting that demand will rise this winter and that there are ample stocks.

Base Metals – We saw mixed results in the performance of nonferrous metals on the LME. Over the past two weeks, copper and zinc moved marginally lower with aluminum, nickel, lead, zinc and tin posting small gains. Most of the gains came late last week when the dollar moved lower. On COMEX, the price of active month March copper futures made new multiyear lows at $2.002 on November 23 as concerns about China and the prospects for an interest rate increase in the U.S. in December dominated trading. The dollar lifted copper to close last Friday at $2.0760 per pound. The rally in copper was tepid considering moves in precious metals and the dollar.

Grains – Grains saw volatility over the past two weeks. January soybean prices moved back above the $9 per bushel level while March corn rallied to over $3.80 per bushel. Wheat moved lower to a new low at $4.655 and then recovered to $4.845 by last Friday. Grain prices received some support from the potential for El Nino to flip to a La Nina during next year’s pollination season. La Nina has caused nasty droughts in the U.S. in the past.

Soft Commodities – Last week was a continuation of volatility and bullish action in the soft commodity sector. While the FCOJ futures market pulled back to just under the $1.40 per pound level, other soft commodities gained. Sugar moved higher over the past two weeks and closed at 15.44 cents per pound after making new highs at 15.85 on Friday. The March-May 2016 sugar spread, closed at a 44-point backwardation up five ticks from the prior week. This signifies the potential for a supply issue this March.

Cocoa futures continued to show strength closing the week at $3390 per ton. The forward curve in cocoa is moving into backwardation on supply concerns. Coffee continues to show signs of life closing at $1.2695 per pound on Friday December 4. Cotton also rallied on dollar weakness closing last week at 64.89 cents per pound, the highest level since late August.

Animal Proteins – Meat markets diverged as cattle fell and hogs moved marginally higher. The long-term average of the live cattle versus lean hog spread has been around 1.4 pound of pork value in each pound of beef value. This spread, on December futures, closed at 2.17:1 last Friday, down on the week. The spreads in February is at the 2.18:1 level — both months spreads moving lower from levels two weeks ago.

Final Comments:

Yet another terrorist event last week means it is likely that volatility across all asset classes will increase. While the correction in the dollar was bullish for commodities, the outcome of the OPEC meeting certainly yielded the opposite effect. The prospects for an interest rate hike in the U.S. continue to rise, which is historically bearish for raw material markets.

There is volatility ahead for all markets and that means there are plenty of profitable opportunities in the weeks and months ahead in the commodity markets for those who understand these markets. The volatile dollar and deviation between U.S. interest rates and others around the world will surely create a bumpy road in all assets classes, particularly in commodities, which tend to be the most volatile of all. The majority of these opportunities will come from spread relationships.

I remain bullish on the U.S. dollar, I believe the dip last week was a buying opportunity and this means that I believe that commodity prices remain in a long-term bear market.

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MACD: Sweet anticipation?

Moving average convergence/divergence (MACD) is one of today’s most popular trend-following indicators in analytical software packages and online services, but research shows the indicator isn’t always so reliable, particularly in short-swing markets.

Developed by Gerald Appel, MACD, like many approaches, uses averages to smooth out fluctuations and reveal the underlying trend. MACD uses two moving averages. One, typically a 26-unit moving average (26 MA), defines the trend; another, typically a 12-unit moving average (12 MA), indicates a change in 26 MA by crossing over it.

The problem with regular moving averages is that they are slow. Notice on the 40-day cycle chart that the crossover comes after the price peak.

MACD attempts to compensate for this delay by anticipating crossovers. Rather than waiting for crossovers, MACD reacts when the averages begin to converge (or diverge).

The MACD accomplishes this by computing delta, the difference between the 26 MA and the 12 MA. When crossovers occur, delta crosses zero. MACD tries to anticipate delta’s crossing of zero by measuring when delta begins to trend toward zero.

MACD measures the trend of delta by yet another average, usually a nine-period moving average of delta. Delta signals its own trend by crossing its moving average.

Thus, MACD is a double exponential average crossover system that tries to anticipate crossovers by signaling when the distance between averages begins to converge.

In theory, MACD should outperform other moving average systems. However, the reverse appears to be true, according to several studies.

For instance, The Encyclopedia of Technical Market Indicators reports that MACD substantially underperforms a 40-week simple moving average crossover rule.

The Dow Jones Irwin Guide to Trading Systems notes that a five-year performance study shows MACD results inferior to Richard Donchian’s 5-and-20 moving average method and the moving average combination of 4, 9 and 18 days.

Flaws of anticipation

Other testing corroborates these findings. The “anticipation” seems to be counterproductive.

The chart of Standard & Poor’s 500 prices illustrates the problem with anticipating. Prices rarely move smoothly. The whole advantage of using moving averages is that they are slow and give signals when a market’s trend is well under way. Trend traders believe the best time to trade is well into the trend, with momentum. While anticipation occasionally picks a top, it more likely picks a false jiggle and gets whipsawed.

The 20-cycle and 40-cycle charts show a subtle aspect of backtesting systems that use exponential averages: Results may vary widely depending on how the averages are “initialized” — that is, what time spans are used.

Ironically, the MACD is a “low pass” filter. The technique filters out high-frequency bumps and allows low-frequency trends to pass through. The standard 12-26-9 MACD combination tends to grow ineffective at approximately 40 time units, although the shorter cycles do not pass through.

The MACD provides a good example of the counterintuitive nature of system design. The delta with a nine-period moving average, intended to overcome the lag between price peaks and signals, actually increases the phase lag for intermediate-term and short-term cycles.

This supports the findings that MACD’s long-term trading results underperform simple systems while MACD’s short-term trading grows progressively worse.

Proponents of MACD generally acknowledge these findings, then elaborate that, well, it’s an indicator, not a signal, and must be used with other indicators, secret sauce and good judgment. So far, there have not been enough of these trading systems incorporating MACD that are precise enough to test historically.

Facing such evidence, you must question the indicator’s popularity. It likely was built on these items:

* Its claim to anticipate is alluring. * It has been touted as an indicator rather than a signal. * MACD provides a parascientific license to generate plenty of action, excitement, anxiety and commissions.

MACD plays an important role in the market ecology, but it just doesn’t happen to be a tool that makes money when used by itself.

The industry has plenty of good systems. The catch is that they require considerable emotional aptitude. Many traders avoid dealing with their emotions by trying to anticipate, optimize and otherwise abandon their systems.

You cannot escape the fact that systems are, by nature, low-pass price filters. They do not predict — they either just dict (say what’s happening) or postdict (say what’s happened).

Working to anticipate the future can be a distraction from the important task of dealing with the present.

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I’ve been a big fan of meditation coach Susan Piver for a very long time. She’s one of the best meditation coaches you can find, especially if you’re not in an area where yoga or meditation is available.

Many traders don’t know where to start, so I thought it would make sense to bring in an expert on the subject and record a real conversation between us about the positive impact meditation has had on our lives. It’s actually quite easy to begin a meditation practice.

I encourage you to sign up for her updates and bring meditation into your life.

Listen up, go inward, and learn to become your own best teacher.

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By Jason Pearce

The Industrial and Precious Metals Connection

Despite the fact that there are different fundamentals that drive the demand for industrial metals and precious metals, there still appears to be a link between the price trends in these two sub-sectors of the metals category. If one were to take a very macro view, perhaps this price correlation is due to the fact that trends in inflation and economic growth impact both.

Using gold as the representative for precious metals and copper as the representative for industrial metals, a long-term price chart of the two reveals two things: First, gold and copper to tend to move in the same direction a majority of the time. Second, it shows that the copper market tends to be more volatile and sensitive to price swings than gold.

Gold Copper overlay (nearest-futures) monthly

Gold Copper overlay (nearest-futures) monthly

It makes sense that copper reacts to fundamental trends more quickly than gold. After all, the global gold supply is so large that the annual production and consumption changes equates to somewhere around one percent of the total supply. It’s almost as if most of the gold in the world simply gets transferred back and forth from the vault of one country’s central bank to the vault of another country’s central bank. Therefore, the value of gold is much more likely to be shaped by interest rates and inflation expectations rather than noticeable swings in actual production and consumption.

Copper, on the other hand, is used explicitly for industrial consumption. More than two-thirds of the world’s red metal goes directly into building construction and electronics. As goes the construction industry, so goes the copper market.


Ugly and Getting Uglier

Both precious and industrial metals have been in bear markets for well over four years now. Slow global economic growth and a lack of inflation have been weighing on both sectors.

Gold (nearest-futures) monthly

Gold (nearest-futures) monthly

With the threat of an interest rate hike from the Fed looming over the market and the US dollar at the highest level in many years, gold continued to push to new multi-year lows this week. Since central bank monetary policy tends to run in trends, the outlook is that the eventual rate hike from the Fed could be the first of many. If not, it would only be because the US economy is now growing at a fast enough clip. Either way, this is not supportive for gold.

Copper also continued its downward spiral as China is now experiencing the slowest economic growth in one-quarter of a century. Since they are the world’s largest consumers, the slowdown is creating a serious glut as copper supplies get stockpiled in the warehouses. There doesn’t appear to be any light at the end of the tunnel, either. Goldman Sachs is forecasting that the oversupply will last until at least 2019.

Copper (nearest-futures) monthly

Copper (nearest-futures) monthly

The current fundamental outlook does not bode well for any commodity traders who are trying to buy a bargain in the metals right now. Furthermore, with both gold and copper tumbling to fresh multi-year lows, the reward-to-risk scenario down here is not anything spectacular for short sellers. On the surface, it would seem that the best metals position for traders and investors to get into right now is flat.

The Relationship between the Blonde and the Redhead

Because of the correlation between the precious and industrial metals, it only makes sense to examine the historic relationship between the two. This can reveal potential trading and investing opportunities that may not exist in the underlying commodities themselves. This is a major advantage that spread traders have.

Since both gold and copper topped at record prices a few years ago, looking at the ratio between the two markets will normalize the relationship and give us a true perspective on whether or not it has reached historically extreme levels during this bear market. We can do this via the futures markets by dividing the value of a 100-ounce gold contract by the value of a 25,000-pound copper contract.

Gold Copper ratio (nearest-futures) daily

Gold Copper ratio (nearest-futures) daily

As it turns out, the ratio recently pushed above 2:1 and surpassed the January high. It is now matching the 2011 peak. This is a significant event. Over the last twenty-five years, the ratio has only been at 2:1 or higher on a few occasions and the financial crisis was the only time it has been considerably above this level. Therefore, we know that the gold/copper ratio has reached an important inflection point.

Far-Reaching Implications

We believe that the gold/copper ratio is at a do-or-die level. If it follows the normal course, we should be looking for a reversal somewhere in this area. If so, it could put the ratio on course for a decline to somewhere around 1.2:1. To do so means that ‘Dr. Copper’ is finally outperforming gold. In all likelihood, this would occur if the world economy is making a rebound. Whether or not this will turn into a secular trend will be left to be seen, but it would mean that we’re at least getting some respite from the current overwhelming bearish environment for commodities.

Gold Copper ratio (nearest-futures) weekly

Gold Copper ratio (nearest-futures) weekly

The reversals off the peaks in 1993, 1999, 2003, 2009, and 2011 allowed copper to outperform for periods of roughly one and a half years to three years. Therefore, a trend reversal in the gold/copper ratio sometime soon would imply that traders should be positioned on the long side of copper and the short side of gold (on a spread basis) through 2016 and beyond. Furthermore, it should be a supportive factor for the China theme and for the commodities markets in general.

Coincidentally, the CRB index has now reached major price support as it has returned to lows similar to the bottoms in 1975, 1999, and 2001. A bottom in commodities in general reinforces the idea that the gold/copper ratio is topping.

CRB Index weekly

CRB Index weekly

After bottoming out in 1975, the CRB index bounced, pulled back into a slightly higher low in 1977, and then launched a multi-year bull market to historic highs. Similarly, the index bottoming out again in 1999, rallied, pulled back into a slightly lower low in 2001, and then underwent another multi-year bull market that sent commodities to new record highs.

The takeaway here is that the raging bear market in commodities in general has reached a level that could potentially mark the end of the meltdown. If it follows the patterns of 1975-1977 and 1999-2001, commodities would make a sizable bounce in 2016, experience one more sizable pullback, and then it’s off to the races again. This pattern would dovetail nicely with the idea of a reversal in the gold/copper ratio and an improvement in the world economy.

On the other hand, a failure to reverse from here opens the door for the gold/copper ratio to surge another 50%. This would put it in the company of the 1980, 1987, and 2009 peaks at 2.95:1, 2.98:1, and 2.83:1, respectively.

Gold Copper ratio (nearest-futures) weekly

Gold Copper ratio (nearest-futures) weekly

Based on the economic conditions of when these peaks in the gold/copper ratio were established, one would have to consider a continued rally from here to be a bearish omen for the global economy. With commodities already undergoing one of the longest bear markets in history and China, the world’s second-largest economy, sputtering along with the slowest growth in twenty-five years, the prospect of further surge in the gold/copper ratio is downright scary. It would indicate that the straw has broken the economic camel’s back.

Structuring a Spread Position

If you have both the capital and the stomach for trading futures, the simplest way to play relationship between gold and copper is to spread one 100-ounce gold contract against two 25,000-pound copper contracts. You want to have twice as many copper contracts because the nominal value is about half that of gold. Therefore, you create a more dollar neutral position by having a similar dollar amount of gold and copper.

Since the copper contract is priced in cents-per-pound and the gold contract is priced in dollars-per-ounce, you can simplify how the spread is plotted by calculating the difference between the value of the sum of two 25,000-pound copper contracts and the value of the 100-ounce gold contract.

You probably noticed that we are calculating the value of the copper first for the futures spread, which is inverse to how we calculated the gold/copper ratio. The reason for this is because a pair of copper contracts is normally worth more than one gold contract. Therefore, we like to quote and plot the spread where the market that usually shows a premium as the lead. Also, the spread chart will reflect the bearish trend seen in both the underlying gold and copper markets.

If you don’t have the risk capital needed to trade the futures contracts, the ETF market is another way you can trade the copper/gold spread. Be careful with the copper ETFs, though. While there is plenty of liquidity in the gold ETF, the copper ETFs are thinly traded.

JJC (x4) GLD spread weekly

JJC (x4) GLD spread weekly

The most liquid copper ETF is DJ-UBS Copper Sub-Index ETN (symbol: JJC). It is trading at approximately $23.90. At the same time, the SPDR gold ETF (symbol: GLD) is trading at approximately $102.90. This puts the GLD/JJC ratio at approximately 4.3:1. Therefore, a dollar neutral spread position would require that you purchase approximately four shares of JJC for every share of GLD that is sold short. As you can see, plotting a spread between four shares of JJC and one share of GLD looks similar to the spread between two copper futures contracts and one gold futures contract on the charts.

Historical Parameters

Historically, the spread between two copper futures contracts and one gold futures contract is in oversold territory once it drops to ‘even money’ or lower (where gold has the premium).

Copper (x2) Gold spread (nearest-futures) weekly

Copper (x2) Gold spread (nearest-futures) weekly

Consider what has transpired the last six times after the copper (x2)/gold spread inverted:


Copper (x2) Gold spread 1993-1995 (nearest-futures) daily

Copper (x2) Gold spread 1993-1995 (nearest-futures) daily

The nearest-futures spread bottomed at -$1,020 (premium gold) in November of 1993. It then rallied for fourteen months into the January 1995 top at +$34,045 (premium copper). The gain was approximately +$35k per spread.


Copper (x2) Gold spread 2002-2004 (nearest-futures) daily

Copper (x2) Gold spread 2002-2004 (nearest-futures) daily

On Boxing Day (December 26) of 2002, the copper (x2)/gold spread bottomed at -$90 (premium gold). It then rallied for a year and one-quarter into the March 2004 top at +$29,765 (premium copper). The gain was nearly +$30k per spread. After several months of consolidation, the rally continued and reached the record-shattering 2006 high of +$136,405.


Copper (x2) Gold spread 2008-2011 (nearest-futures) daily

Copper (x2) Gold spread 2008-2011 (nearest-futures) daily

The 2008 financial crisis crushed the copper (x2)/gold spread. The capitulation point was reached when it breached the 1980 historic low and posted a new all-time low of -$29,380 (premium gold) in March of 2009. From there, the nearest-futures spread began a two-year ascent into the 2011 Valentine’s Day nadir at +$94,965 (premium copper). This rally of +$124k per spread was one for the record books.


Copper (x2) Gold spread 2011-2012 (nearest-futures) daily

Copper (x2) Gold spread 2011-2012 (nearest-futures) daily

The spread inverted again in 2011 and bottomed out at -$8,730 (premium gold) in October of that year. A six-month advance into the April 2012 high of +$28,295 (premium copper) followed, sporting a gain of approximately +$37k per spread off the low.


Copper (x2) Gold spread 2012-2014 (nearest-futures) daily

Copper (x2) Gold spread 2012-2014 (nearest-futures) daily

In November of 2012, the copper (x2)/gold spread dipped just below ‘even money’ and established the bottom at -$815 (premium gold). From there, it worked its way higher into the 2013 New Year’s Eve top at +$51,845 (premium copper). That’s a little over +$52k per spread in thirteen months.


Copper (x2) Gold spread 2015 (nearest-futures) daily

Copper (x2) Gold spread 2015 (nearest-futures) daily

This year, the spread inverted in January. It bottomed out at -$4,615 (premium gold) by the end of the month. This led to a sizable rally into May Day where it topped at +$29,125 (premium copper). The three-month bounce of +$33,700 per spread was certainly an event worth trading this year.

More Food For Thought

We’ve established the fact that the gold/copper ratio is at a potential make-or-break level. We also told you how to structure a position if you want to trade it. Here are a few more things that a futures trader might want to consider when approaching the current situation.

First of all, the gold/copper ratio has reversed from current levels more often than it has broken out. It seems that the way to bet with the probabilities then is to look to trade a reversal. If you agree, you will initially want to get positioned long in the copper and short the gold.

Next, we have to keep in mind that there were a few occasions where the copper (x2)/gold spread plunged substantially below the ‘even money’ waterline before finally bottoming out. This should make a trader bit wary of trying to catch a falling anvil by picking the bottom down here. Look for some sort of evidence of a price reversal. At the very least, make sure the downward momentum is slowing noticeably before jumping in.

From a time perspective, the current inversion is getting quite mature. It has been a little over three months since the copper (x2)/gold spread inverted and there has been no sustainable rallies yet. In the last twenty-five years, the longest period where the spread flip-flopped either side of the ‘even money’ mark before taking off was 4 months and one week. This occurred during the depths of the financial crisis. The other five durations of oscillating either side of ‘even money’ before the train finally left the station was one day (in 2002), one week (in 2012), one and a half weeks (in 2015), six weeks (in 1993), and 2 months and one week (in 2011). From a time perspective, one might think that a turnaround in the copper (x2)/gold spread may be close at hand.

Resistance levels

There are three resistance levels I’m currently monitoring for the March-February copper (x2)/gold spread. A breakout of any of them could be used as an entry signal on the long side. They could also be used to scale into a position by entering on the first breakout, adding on a second and raising protective stops, etc.

The ‘even money’ level is an important marker for the spread. The March-February copper (x2)/gold spread closed below this level for more than a week and counting. Therefore, a close back above this level could be a clue that it’s ready to start a move to the upside. It would be kinda like pushing a volley ball under water and seeing it pop back above the surface when you take your hand off.

March-Feb Copper (x2) Gold spread daily (even money mark)

March-Feb Copper (x2) Gold spread daily (even money mark)

A rebound from here would be even more compelling since the spread is probing important price support at the January low. Could a double bottom-type formation mark the end of the bear market in the spread? Better yet, how about a Wash & Rinse low (failed breakdown) to trigger program and algorithm selling before it finally makes a sustainable upside reversal?

March-Feb Copper (x2) Gold spread daily (late Sep-early Nov tops)

March-Feb Copper (x2) Gold spread daily (late Sep-early Nov tops)

A close above ‘even money’ would allow the spread to take a shot at price resistance between the similar highs of late September and early November at and +$5,650 and +$5,790, respectively. A breakout above this price barrier would alter the current price structure and add some confirmation to the turnaround.

March-Feb Copper (x2) Gold spread daily (100-day MA)

March-Feb Copper (x2) Gold spread daily (100-day MA)

Finally, the declining 100-day Moving Average is another technical resistance level that you may want to keep tabs on. Since peaking out on May Day and closing under the 100-day MA in mid-June, the March-February copper (x2)/gold spread has not been back above the 100-day MA yet. The bounces in mid-September and early November both stalled out just below this technical barrier. Therefore, a two-day close back above the 100-day MA (currently near +$5,000) would be another indication of a bullish trend change in this spread.

Economic Weather Patterns

Whether or not you trade the spread between gold and copper, the ratio between these metals will still serve as a key barometer for other trades and investments. Traders and investors alike should be paying close attention to how this plays out.

A further surge in the gold/copper ratio and a corresponding collapse in the copper (x2)/gold spread would be reason to seek shelter. A storm is coming. You will likely want to be positioned defensively or short in such conditions. Conversely, a reversal from here would offer a great buying opportunity for traders and tell investors that there are blue skies ahead in the forecast.

The gold/copper ratio will serve as your economic radar, so be sure to check it often. Just like the weather, market trends can change quickly.


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