Technical Analysis: Don't Worry, Be Gappy

• The live cattle futures market has seen a lot of noncommercial buying interest over the last number of months despite futures spreads that continue to indicate neutral-to-bearish supply and demand.
• Recent concerns over a potential US banking system meltdown likely added to the round of long-liquidation seen in the live cattle market.
• However, there are still long-term signs that indicate the market may not be done going up.

Just as I was settling in to write this piece, CNBC came out with a headline that asked, “Should you be worried about your money, your bank, or the U.S. banking system?” Upon reading this, I was reminded of a couple quotes: First from Mark Twain, “I’ve had a lot of worries in my life, most of which never happened.” The second was borrowed by Bobby McFerrin to make his hit song, “Don’t Worry, Be Happy”. While I think there is cause for concern given some of the latest banking developments, as I said in my previous article I’m not looking for economic Armageddon, but at the same time I was one of those who could see a potential train wreck[i] following US banking deregulation of 2018. 

One of the concerns in commodities is another banking breakdown similar to what occurred in 2008, and what the Dodd-Frank bill was supposed to avoid until it was neutered by a bi-partisan act in 2018, is that the complex, various sectors, and specific markets could be hit by a wave of investor long-liquidation. To me the more vulnerable markets are those showing unchecked noncommercial buying enthusiasm while futures spreads indicate real supply and demand is neutral at best, bearish at worst. Two markets that jump out at me are feeder cattle and live cattle. I talked about feeders last time, and why I liked the strategy of buying put options, so I’ll focus on live cattle with this piece. 

Coming out of the weekend, live cattle futures contracts left technical price gaps on their respective weekly charts. A price gap is just that, space between the previous period’s low and this period’s high (for a bearish gap) where no trade occurred. A look at the more active June live cattle contract (LEM23) shows last week’s low was $158.50, with Monday’s open at $158.275 and session high of $158.425. Along the way the June issue also posted a low of $157.25 before closing at $158.20 down only $0.45 for the day. The late rally set the stage for Monday morning’s price gap to be filled, and sure enough, early Tuesday saw the contract reach a high of $158.55, just enough to close the gap and remove one potentially bearish technical hurdle. 

But what happened in live cattle? The latest CFTC Commitments of Traders report (legacy, futures only) for positions as of Tuesday, February 21 showed noncommercial interests increasing their net-long position to 104,274 contracts, the largest net-long position since the week of May 21, 2019. However, the contract’s daily chart shows a bearish key reversal on February 24 confirming a new short-term downtrend was in place. A classic 3-wave pattern resulted in Monday’s low, $4.65 off the late February. This tells us to expect noncommercial long-liquidation in subsequent CFTC CoT updates. 

Why would investment traders be liquidating longs? There have been rumblings of problems in the banking sector for a while now, and live cattle above $160 is historically high. This means the risk-to-reward ratio may favor the downside, at least short-term as it turned out. Additionally, the June-August futures spread was still in neutral-to-bearish territory through late February. Therefore, if investment traders were concerned about a possible financial meltdown, while holding futures contracts that were historically high and futures spreads were bearish, unloading some of those holdings seemed a good choice. 

Does this mean the rally in live cattle is over? Not at all. Recall I’ve talked about how the cash corn market of 2020 through 2024 resembles that of 2010 through 2014. Similarly, the last time live cattle’s cash index (LEY00) made this type of run was during 2013 and 2014 with a high of $173.36 in November 2014. The latest calculation had the same index priced at $165. 

Technically it still looks like June live cattle have put in an intermediate-term top on its weekly chart, despite the price gap being filled Tuesday. Now we’ll see if investment traders continue to worry about banking and liquidate long futures positions or turn happy thinking the cash market is going to continue to go higher and start buying again. Stay tuned. 

[i] Not to make light of the recent rash of US train derailments, but the previous US administration also removed a number of key rail industry safety regulations.

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