Some relief could be on way at the butcher shop

Key points:

• Live cattle spot prices rallied more than 4% over the past 5 sessions
• At the same time, the spot price closed at a 252-day high
• After similar setups, cattle prices tended to decline over the next 6 months

Could we see some relief on the way at the local butcher shop  

Live cattle are full-grown cattle that get slaughtered for meat and other products when they reach a certain weight. Spot prices for them closed at a new high this week on solid short-term momentum.

In a recent note, I highlighted how one should be mindful of a bull trap after a momentum breakout in coffee. Since that signal, the front-month coffee futures contract has fallen over 10%.

Could we see a similar fate for live cattle after its momentum breakout?

Similar signals preceded negative returns

While the 1-month time frame suggests the recent momentum could continue in the near term, a longer-term view looks unfavorable, especially the six-month window. Between 1979 and 2008, the six-month time frame showed a loss in 15 consecutive instances.

A big picture perspective

A sustained uptrend, whereby the two-year rolling return exceeds 66%, is extremely rare, with only two other instances since 1971. In both cases, the momentum continued in the near term. However, cattle closed lower at some point over the next three to six months.

For those in the U.S., one of the purest plays on this index is the iPath Series B Bloomberg Livestock Subindex Total Return ETN (COW). This is not a comment on the acceptability of COW as a trading or investment vehicle; rather it's simply to note that it is one of the few ways for non-futures traders to bet on or against livestock prices.

What the research tells us...

Live cattle closed at a new high with a surge in short-term price momentum. While the near term suggests the thrust could continue, a longer-term outlook is unfavorable, especially six months later. Like most mean-reverting commodities, we must be mindful of a potential bull trap, especially after a sizable multi-year rally.