The live cattle market spent all of spring and early summer in a tight trading range roughly bound by $155 on the high side and supported near $147 on the low side. The market has finally created some action by falling through the support near $148 over the last two weeks with the current low now near $145. 50. Chart readers would see the fall through this level as a breakout and anticipate further weakening of the cattle market. However, there are two very good reasons this may be a short trap triggering a reversal rally into expiration.
First of all, breakouts are defined by a move to new price levels accompanied by increasing volume and open interest as the market's participants accept the new price levels. This is not what we've seen in the August live cattle futures. Open interest declined by more 10% on July 10th, the day the market fell through the $148 support. Furthermore, open interest has declined every single day for more than a week. This has far more to do with small traders exiting the market than it has to do with the August contract's expiration.
Meanwhile, as small traders are exiting the market at these discounted prices it only makes sense that the commercial traders via packing houses, processors and feedlots are locking in their future inputs at a better basis. Commercial packers had already begun buying on the market's first dips to $148. The commercial bid held the market for five straight days before sellers gave into a short-term rally prior to finally falling through. In fact, commercial traders have been buyers in each of the last five weeks, purchasing more than 12,000 contracts during last week's weakness. Finally, keep in mind that as the commercial traders' position grows during declining open interest, they control a larger and larger percentage of the market.
Moving to the topic of expiration, let's take a look at the August live cattle futures' typical seasonality according to the folks at MRCI.com. Their seasonal analysis is, in my opinion the industry standard. I've added the dates on the chart as points of reference. First notice day in August live cattle is August, 10th. This leaves two and a half weeks for this market to find its seasonal bottom.
The implementation of all this relies on a move back above the $148 area to trigger a COT Buy Signal. This would signify the reversal we are anticipating while keeping us out of a market that is still in decline. If this trade triggers, we'll place a protective sell stop at Monday's low of $145.525 and expect this market to rally into expiration. Lastly, long trades should be offset prior to first notice day to avoid any potential delivery issues or, charges. If you're not familiar with the delivery process or first notice dates, call your broker. Better yet, call us.
