Spread trading no longer works
21 February 2022
Commitments of Traders (COT) report
4 March 2022
Today I want to analyse lean hogs. I am not used to trading with meats, except for some spreads that I have been following for a decade now. On lean hogs there are a couple of interesting situations that I am going to show you.
The first is a normal calendar spread, more precisely HEM22-HEZ22 and below you can see the chart with the two seasonal patterns at 5- and 15-year.
The spread has a bearish seasonality starting in December and ending in April. In December it moved sideways in a narrow range, but in January it started a strong rise. A rise that may not even be over. If in fact I take the stacked chart, you can see that it is true that this year the spread is above all the previous nine years, but also that in 2021 the spread continued to rise while in 2014 it made a much bigger rise before starting to fall.
All this is confirmed by the Continuous histogram that you can see below.
The spread over the last 20 years has spent 98% of the time above zero but rarely with such a wide contango, well outside the 5th-95th percentile range. However, as you have seen with the Seasonality stacked chart, it has reached an even wider contango (in 2014).
However, the Seasonality by month chart is perhaps the most interesting one.
The chart shows that March has been bearish 9 out of 15 years, 3 in the last 5 while April has been bearish 11 times out of 15 and in all of the last 5 years. I remember that the chart only indicates whether each month's performance was bullish or bearish, it says nothing about the extent of the rise/fall.
This leads me to cautiously consider selling the spread in a few weeks' time, waiting either for a higher price (in the $40 area) or for the start of a trend reversal.
The term structure is in line with its 5- and 15-year averages while the COT, although I tend to ignore it with meats, does not yet give me signs of a reversal of the underlying.
The only news about lean hogs that interests me is that finishers are losing up to 30% of their pigs to PRRS. And losing 30% of pigs means there will be a supply problem in the market. PRRS is a virus that causes a disease in pigs, called Porcine Reproductive and Respiratory Syndrome.
So, in all likelihood the price of lean hogs is set to rise in the coming weeks/months. This goes against my analysis since the spread, as shown below, follows the trend of the underlying (the closest delivery).
Chart dedicated to all those that I hear (and read) that "it is not important to know the underlying since we make trading on the spread." Indeed...
The spread is certainly very interesting graphically, less so from a fundamentals point of view. To lower the risk, you can opt for the HEM22-HEQ22 spread. The two much closer deliveries make it a bit quieter. I just show you the chart with the two seasonal patterns at 5- and 15-year.
However, for all that has been said and seen, at the moment it is much wiser to wait and see how the pig epidemic situation may evolve (although I am not very optimistic) before undertaking any type of trade. My target for the lean hogs is $120, and once it gets to that level, I will study a possible short entry on the spread.
The second interesting situation for lean hogs is offered by the live cattle/lean hogs ratio. You can see the chart below.
The chart is very interesting but even though the ratio has fallen below 1.4 it is still premature to buy the LE-HE spread. Mainly because if lean hogs continue to rise in price due to the epidemic, the ratio (and consequently any type of spread) will continue to fall. Personally, I will wait until the ratio (most likely) falls below 1.2 before building a spread and studying its buy price
In conclusion, lean hogs is certainly the most interesting of all meats, but also the most difficult to trade right now. This type of situation requires a lot of experience, patience and wisdom.
Today I want to analyse lean hogs. I am not used to trading with meats, except for some spreads that I have been following for a decade now. On lean hogs, there are a couple of interesting situations that I am
I am a macroeconomic and financial analyst with over 30 years’ experience, including two years as a fund manager. I specialise in currencies and commodities, and I am the author of several successful books on trading, macroeconomics, and financial markets.
1 Comment
Thanks for the post. Where can I read more about PRRS?