[Educational] This Ag-gravating Pattern Is Playing Out Again

Here's where the first case of this pattern developed back in late January. What we're looking at is a multi-year base in Wheat and prices attempting to break out to new highs after a strong run over the intermediate-term and no consolidation.

At the time, commercial hedgers were also short so our expectation was that this initial breakout would fail and we'd see further consolidation before an eventual long-term resolution of this base. Over the coming six weeks, prices would fall nearly 15% from their highs where they are today.

Click on chart to enlarge view.

So let's review what made this specific chart a higher-probability setup, despite being a counter-trend call.

1. Prices had rallied 30%+ in six months and were approaching a long-term resistance level
2. Prices immediately tried to break out, without any consolidation allowing buyers to reset
3. Momentum diverged negatively as prices made new highs
4. Prices quickly closed back below long-term resistance, confirming a failed breakout and defining our risk on the short side
5. Positioning/sentiment was overly optimistic in the near-term with commercial hedgers net short, which they rarely are in Wheat

As you can see from this list, the tools and tactics we're using are the same as we use in Equities, Fixed Income, etc. There are nuances to each market, sure, but the core of our approach and execution stays the same.

Once you recognize the underlying conditions driving a move, you can replicate that trade idea in other assets.

Here's Cocoa confirming the same failed breakout/bearish momentum divergence a month later by closing back below 2,900

And here's Sugar, falling more than 10% in the last two weeks.

Big bases, stretched sentiment and price action, waning momentum...all preceding a significant decline in these markets.

That brings us to Rough Rice. It looks familiar, doesn't it?

A failed breakout from a long-term base, bearish momentum divergence, commercial hedgers with their largest net short position since 2011, and well-defined risk on the short side?

The logical conclusion here is that if prices are below 13.25 in Rough Rice, then downside risk and opportunity cost are elevated. Maybe it plays out differently, working these conditions off through time rather than price, but if it follows a similar path to its peers then we'd expect a move towards the next major support level near 11.10.

In addition to paying attention to similar patterns playing out in the same space, it's also important to consider the overall backdrop for the asset class you're trading. Throughout this year, intermarket signals like the Treasury Inflation-Protected Securities/Treasuries ratio, Copper/Gold ratio, Australian and Canadian Dollars and Equities, etc. have all been signaling weakening inflation expectations among market participants. Commodities as a group, as measured by CRB Commodity Continuous Index, peaked at the start of the year and have been crashing since.

That is not the type of environment where we want to be buying breakouts aggressively. In fact, it argues for taking opportunities on the short side and seeing how they develop.

Nevertheless, I hope this provided some insight into how we approach markets and why we've been focused on Agricultural Commodities recently.

Believe me, I get it. The Dow is swinging 800 points per day, nobody wants to talk about Wheat or Sugar or Rough Rice. Luckily for me, my job isn't to force a square peg into a round hole. I'm here to look for attractive reward/risk scenarios across markets, no matter how unloved or boring they may be. The fact of the matter is, the best trade is often no trade, so when we wait months or years for attractive conditions like the ones discussed here to develop, we act on them.

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Thanks for reading and please let us know if you have any questions!

Allstarcharts Team