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Mikula Forecasting
Company: Strategy #28:
Spread Analysis
====================
MarketWarrior 4.0
Written by: Patrick Mikula CTA
Copyright (c)2003-06 by Patrick Mikula All Rights Reserved.
(Please to not copy or foreword this article).
Mikula Forecasting Company
P.O. Box 152672
Austin, TX 78715-2672
USA
www.MikulaForecasting.com
support@MikulaForecasting.com
====================
When you are analyzing a market using spreads you need to
understand that a spread can tell you different things in
different markets. The agricultural markets have a crop
season which moves from planting to harvesting commodities
such as crude oil or stocks have no such season. In this
article I will discuss how a spread can help you identify a
bull market in an agricultural market. The chart below shows
the soybean market. In the soybean market after the soybeans
are harvested they must be stored which is not free. There
are costs for insurance, the interest costs on loans that
can not be paid back until the grain is sold and rental cost
for bins if the farmer does not have enough storage space.
These holding costs are the difference between the different
futures contracts. For example consider future contracts
that expire two months apart in January, March, May and
July. The March contract would need to be priced as the
January contract price plus 2 months of holding costs. The
May contract would need to be priced as the January contract
price plus 4 months holding costs. The July contract would
need to be priced as the January contract price plus 6
months holding costs. When the nearby contract price moves
above the father out contracts it indicates that customers
are willing to pay a premium to get the agricultural product
right now because they believe prices will be going up in
the future. When this happens it indicates that a bull
market may be in-force and you should watch this market for
an uptrend.
The chart below shows the July 2005 soybean contract which
is the nearby contract as price bars. Also shown is the May
2006 soybean contract which is a farther out contract and is
shown as a blue line. The spread line in the sub-chart shows
shows the difference between the two contracts. Notice that
the nearer contract moves above the farther contract in
early March 2005 around the price 626. This indicates that
there is strong buying in this market. Between points A and
B on the chart below the nearer contract was above the
farther out contract and the market moved up from the 626
level to approximately 755 during this four month time
period.
The soybean market is currently displaying a normal market
where the farther out contracts are higher price than the
nearby contracts. The chart below shows a normal soybean
market with the January 2006 contract shown as price bars
and the July 2006 contract shown as a red line. This is not
the opposite situation from the chart above and does not
indicate a bear market.
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