Grains, Bonds and Softs Showing Weakness

Three themes to scrutinize as we settle back into a full trading week are weakness in grains, 30-year bonds and 10-year Treasuries failing to confirm weakness in stock index futures, and potential multiday reversals in softs contracts.

Corn and wheat have been in downtrends since spiking in September, but beans have remained resilient. Now the bean complex is showing signs of reversing: March soybean oil (BOH3:CBOT) logged a top reversal bar Monday and is confirming an important turnaround may be at hand by following through to the downside in Tuesday's session.

Here's the pattern. On Friday, bean oil rallied to a new contract high, but was unable to sustain the gains, closing at opening levels, which was the low of the shortened session, in a candlestick known as a graveyard Doji.

The Doji denotes a potential change in the trend. On Monday, bean oil completely engulfed Friday's Doji, tracing an outside bar down in a convincing reversal bar formation. Early in Tuesday's session, we saw downside follow-through, price action that works to confirm the reversal pattern.

The swift reversal from contract highs leaves bean oil in the lower tranch of its November consolidation and suggests this market has put in an intermediate-term top. Corn has been under pressure since tracing its own graveyard Doji candlestick on Sept. 9 and has also been suffering from levels of aflatoxin contamination considered unsafe by the U.S. Department of Agriculture.

One of the weakest things a market can do is begin a session on its high and end on its low of the day. March corn (CH3:CBOT) has done this consistently lately, closing on its lows (or below the midpoint) for the past six sessions. Also notice that the 20-day simple moving average has contained any pullbacks from the low.

Also showing pronounced weakness, March wheat (WH3:CBOT) provided back-to-back opportunities to short at its most recent pullback from a low trigger (the low of the high bar in the pullback) on both Friday and Monday. A decline Tuesday confirmed weakness out of the pullback. Fundamentals aren't helping here, as weekly export sales figures came in 21% below the four-week moving average.

This price action demonstrates considerable weakness, although traders are likely to fade the breakdown in a potential multiday, countertrend setup.

March T-bonds (USH3:CBOT) and 10-years (TYH3:CBOT) are rebounding weakly despite a two-day selloff in stock indices. The weak recovery works to confirm the view that debt futures have put in a multidecade top.

Breakout or Fake Out?

In the breakout/fake out department, coffee and sugar may be providing opportunities to fade the prevailing trend. As I've pointed out before, many trend-following commodity funds have systems that initiate long positions on the breakout of a one-month high and initiate short positions on a breakdown below one-month lows.

Contrarian traders will fade, or trade against, the breakouts or breakdowns in short-term, countertrend trades. Such trades generally last one to four days.

March coffee (KCH3:NYBOT) hit a one-month high Monday, but got hammered down Tuesday following a lap-down opening. This price action off the one-month high suggests coffee will pull back, possibly to $68.50. However, coffee did log a stealthy contract, closing high on Monday, suggesting the contract has the strength to test and close above the October high of $76.00 soon.

March sugar (SBH3:NYBOT) has shown marked strength. However, its speedy run-up leaves it particularly vulnerable to contrarian traders who fade breakouts. Should this market trade below the previous high around $7.77, consider fading (selling short) the breakout for a one- to four-day selloff. Risk can be narrowly defined by using Tuesday's high at $7.89 as a protective buy stop.

Marc Dupee is an independent trader and co-author of the book The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he was short bonds, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to Marc Dupee.

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