Let me begin by saying the historic rally in the livestock sector, led in large part by the live cattle market, has been driven by fundamentals. Tight supplies and continued strong demand have created the situation where the cash markets in live and feeder cattle continue to run well above the sky high futures price. And as most of you know, there is no one better when it comes to analyzing and writing about the livestock markets than DTN's own John Harrington. His "Harrington's Sort and Cull" blog and "The Market's Fine Print" bi-weekly column are must reads, not just for those in the livestock industry, but for anyone look for insightful and entertaining information.
Now for my point of view. As you know, this blog takes a look at the technical, or chart-based, side of the markets. The past months have seen me post a number of discussions on various livestock charts, usually with the bottom line of not wanting to be the first to step in front of the runaway train that has been the livestock sector.
This one could be more of the same, or entirely different. I'm not quite sure yet.
A look at the attached weekly chart for the October live cattle contract shows a market that has been in a strong uptrend, until last week. After posting a new high of $158.00 the contract fell below the previous week's low of $152.60 before closing well below that mark at $151.65. Those familiar with this blog will recognize that technical pattern as a key bearish reversal, normally associated with a turn in the market from an uptrend to a downtrend.
The problem is we've seen this same pattern in the past, most recently the week of May 19. As is easily visible on the chart, the market hardly hesitated before rallying from that week's close of $141.50 through last week's high, a gain of $16.50. But a closer look at a variety of technical studies shows what could be the difference this time around.
Weekly stochastics (second chart) have been running above the overbought level of 80% for the most part since the beginning of 2014. Over the course of the year there have been a number of instances of what look to be bearish crossovers (the faster moving blue line crossing below the slower moving red line), though none of them were in conjunction with a bearish signal on the weekly charts. Again until last week.
As the October contract finished off its key bearish with Friday's lower weekly close, stochastics posted a corresponding bearish crossover that included the important component of occurring above the oversold level of 20%. If we go back to the same technical patter from the week of May 19, we see the crossover by weekly stochastics was done with the faster moving blue line at 76.8%, slightly below the 80% level. This slight difference could be the fine line between what was resulted in a continuation of the uptrend and what might be the move to a secondary (intermediate-term) downtrend.
As stated above, the underlying fundamentals of live cattle seem to be bullish, as indicated by the still strong basis (difference between cash and futures prices). However, if we look at the October to December futures spread (third chart, green line) we see what appears to be the early stages of a downtrend developing. Based on weekly closes, the spread has pulled back from its high of $0.85 (week of June 30) to last week's settlement of (-$1.35). While this week has seen a small uptick (-$0.95), it is important to see what the next move is. A weekly close below last week's settlement would signal a strengthening downtrend (more bearish commercial view of the market) while continued support in the October contract (in relation to the December) could result in a test of the recent high.
Noncommercial activity is also a concern. Market volatility has steadily climbed to its current reading of 11.6%. As a general rule, large noncommercial traders don't like increased market volatility as it increases their risk exposure. Therefore, higher volatility readings tend to lead to noncommercial long-liquidation that ultimately drives the futures market down.
The most recent weekly CFTC Commitments of Traders report (positions as of Tuesday, July 8) showed noncommercial interests holding long futures of 151,855 contracts. While still substantial, and dangerous to a market threatening a bearish turn, it is down from its peak of 176,350 contracts from the week of March 31, 2014.
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.