Technically Speaking
Darin Newsom DTN Senior Analyst

Tuesday 03/25/14

June Lean Hogs: Squealing Like A, Well, You Know

If you think back to bygone days of wild boar hunting, the hunters would chase down the boars on horseback in hopes of spearing them with a lance or spike. It was this activity that led to the two famous lines, "bleeding like a stuck pig" and "squealing like a stuck pig".

Source: DTN ProphetX

I couldn't help but think of the latter when looking at the June lean hog weekly chart, and putting myself in the position of those who have recently bought thinking the rally should continue. One day into the new week and the possible spike high looks like it could be lethal.

To begin with, take a close look at last week's activity. Though it is hard to see at a distance, the chart shows a gap between last week's low ($128.85) and the previous week's high ($128.375). Turning to Murphy's classic "Technical Analysis of the Futures Markets", page 130 starts the discussion on V Formations of Spikes.

The first precondition for a spike reversal is "a steep or runaway trend." A look at the weekly chart shows this clearly, starting with the low of $87.025 from the week of March 18, 2013. The second precondition is the establishment of a key reversal day, or an island reversal pattern. While a key reversal was not established, the fact that a price gap emerged last week leaves open the possibility of an island reversal. This won't happen this week, unless Friday's close is near the weekly low and next week starts with a sharply lower open.

Murphy also points out (pg. 133) that "the subsequent decline usually retraces a significant portion of the prior uptrend (as much as a third to 50%) in a very short period of time." This fits with my theory that the commercial outlook, known to us through futures spreads, set the tone for how far a market may retrace. A market with bullish spreads may see a minimum retracement of 33% to a maximum of 50%. In the case of lean hogs, the June contract continues to hold a premium of about $2.90 over the August contract.

But take a look at the trend in this spread (bottom study). Notice that there has been a sharp decrease in recent week's following back from the high of $5.30 (weekly close only) the week of March 10, 2014. Comparing to the five-year range, the spread remains bullish, just not as bullish as it recently was. This commercial outlook would imply that the market should retrace 33% to 50%, putting the possible target between $117.975 and $110.225.

But what if the spread continues to weaken and noncommercial traders increase their pace of long-liquidation (third study, blue histogram)? If we look for price support at previous highs we see there is a pocket of trade from late October 2013 through late January 2014 capped near the $102.425 level. Note that this is almost spot on with the 67% retracement level of the previous uptrend. Therefore, it is easy to picture a situation, particularly since we are discussing the always overly dramatic hog market, where the June contract falls all the way back to this bottom level of support.

Weekly stochastics (second study) also suggest that the secondary (intermediate-term) trend has turned down. Last week, after the new high of $133.425 was posted, this weekly momentum study established a bearish crossover with the faster moving blue line (94.3%) moving below the slower moving red line (95.7%) and both still well above the overbought level of 80%. This signal, in conjunction with the developing spike high on the weekly price chart, signal that hog market bulls could soon be squealing.

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Commodity trading is very complicated and the risk of loss is substantial. The author does not engage in any commodity trading activity for his own account or for others. The information provided is general, and is NOT a substitute for your own independent business judgment or the advice of a registered Commodity Trading Adviser.

Posted at 9:03AM CDT 03/25/14 by Darin Newsom
Comments (4)
The spread most likely is weakening because if you look at the state by state breakdown of PEDV occurrence, it didn't really take off in Iowa and Minnesota until December, i.e. where the greatest hog concentration is. Bottom line is, we are probably dealing with a dynamic that hasn't been seen before in the hog market that is going to make a lot of technical analysts as well as fundamental analysts look pretty silly before all is said and done. As the old adage goes, the market will move longer than the trader can stay solvent.
Posted by Brandon Butler at 1:18PM CDT 03/25/14
Thank you for your comments Brandon. I agree that PEDv is the Black Swan that can make fools of analysts long-term. But if I just look at what the charts are showing at this time, the June lean hog contract looks to have established a spike top. Can the picture change? Certainly. It will be interesting to watch, from an analytical point of view, how all this plays out on the charts. Also, as I've often said, chart signals have never been as reliable in the livestock sector as they are in other markets. Why? Because in livestock, historically, the cash market has driven futures. The question is now, has increased investment participation the last few years skewed that relationship? Thanks again.
Posted by DARIN NEWSOM at 5:22AM CDT 03/26/14
I thought about this a bit more Darin. While using both fundamental analysis and technical analysis is a must for marketing/trading, in this type of market, technical analysis will have to be leaned on more than normal. After all, we are dealing with two things...a HUGE unknown as to the decline in production that will occur in late summer/early fall, as well as a very emotionally charged trading environment (i.e. PANIC). A week ago all it was doing was going up. Now everyone and their dog wants out as soon as they see the cutout and cash stop going up at a buck or two clip a day. What's changed? Not much. We haven't even gotten to the real reduction or the peak demand/low supply time of the year. So all of this irrationality will need to be "smoothed" by using the technicals. As an aside, I ask "Where's it going?" Who knows. But I do know that the fireworks are far from over. It seems telling to me that those that own the most hogs (i.e. those involved the closest with the packing industry that have the most information in regards to the decimation PEDV has caused) were buying with both hands in a period of time that still has plenty of supply.
Posted by Brandon Butler at 8:08AM CDT 03/26/14
Your comments go to the heart of technical analysis; that price action reflects all known, and unknown, factors at play in the market. The issues is the Black Swan, or Chaos Theory, where an unforseen event at a critical time causes a dramatic change. Is PEDv such an event, or are futures spreads accounting for the growing problem? Remember, futures spreads show trends just like futures markets, with direction reflecting the market's view of fundamentals. Again, thank you for your comments and interesting discussion.
Posted by DARIN NEWSOM at 8:52AM CDT 03/26/14
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