Tight Ethanol Markets

The Jan Ethanol futures continue to strengthen versus Feb, moving to a full 5 cent/gallon premium. This is a pretty steep backwardation for 1 month on the calendar, though we have seen this kind of action in ethanol for several months now. So far this "squeeze" hasn't been powerful enough to drive ethanol higher relative to corn, but it seems to me that we will likely see that eventually. For the past few months the corn market has been so strong that it is tough for any commodity to outpace it, but if (when) we see a pullback there, the ethanol market may finally outperform.

A similar kind of narrative may also describe the oats market. While oats are close to their highs, there hasn't been the speculative or institutional interest to drive oats to new highs in the way we have seen corn chased higher. With wheat, and especially Spring Wheat, much stronger along with corn and beans, it is hard to make a case for oats "winning" many acres at current prices. So with current stocks allowing Dec10 to trade up to a premium to March11, it seems that tightness will continue. As with ethanol, this should eventually lead to an improvement in the ratio against corn. (While corn inventories may be tight in 6 months, the nearby calendar spread shows little immediate concern.)

Another Bite at the Oats

A month ago I said that I liked long March Oats vs Corn and the ratio moved quickly in favor of the Oats...and then all the way back. So we are getting another chance to buy pretty cheap oats: Oats at or below 62.5% of corn. That's my somewhat arbitrary threshold for cheapness. Certainly, oats can get cheaper--maybe all the way down to 50% of corn. If we saw that the corn market was tight and the oats market well-supplied, perhaps I would wait for more attractive levels. But today we have March/May Oats at 45% of full carry while Corn is 65-70% of full carry. So the Oats market, where Dec futures traded up to 20 cents premium to March, is clearly tighter...

I didn't have a lot of patience with the long July MGEX/ short CBOT--dumped it at the lows below 55 cents premium MGEX. Ugly. Still keeping the long Dec11 MGEX/short KC which is now available at better levels. Also keeping the long ethanol (now Feb) vs short Corn.

MGEX Wheat Dips Vs. CBOT

Considering the smallish positions I have, I got nicked pretty good today. The Dec11 MGEX contract dropped 3-4 cents vs CBOT and nearer futures like July lost 6-7 cents. Ouch. The outright moves were not so large that the "tail hedge" was meaningful--MGEX was only up about a dime.

The ethanol market was a bit kinder to me. The ethanol/corn crush didn't move much my way but the front end on the ethanol market stayed very firm with Jan trading 1.5 cents premium to Feb. So I like how that's shaping up.

I Don't Trade Every Day

And if I'm pretty sure that I'm not going to trade, I don't really follow the markets that much. Right now I have my Long Dec11 MGEX/ Short KC intermarket position (not very large) and I have some long front/short back calendar spreads. Nothing to get excited about.

I also have the Long ethanol/ Short corn position, but that is smallish and meant to be long-term as well. Kind of disappointing that ethanol futures only traded about 300 lots today as the market made new highs, but hopefully that is mostly a holiday season effect.

Same Stuff as Yesterday

Adding Dec11 MGEX vs KC.

Have a good weekend.

Hard to Stay Away from Irresistible Hard Spring Wheat

As much as I would like to sit back and wait for bargains to throw themselves at me, I feel I am missing out if I don't have a trade that I like. In general, I like intermarket spreads in wheat where I short CBOT wheat; Soft Red Winter Wheat has usually traded at something like a 10% discount to Hard Red Spring Wheat due to its lower protein content, but nowadays, CBOT wheat also incurs much higher storage rates due to the exchange's VSR rules.

Right here, I feel that the market has pushed MGEX HRS wheat to a big enough premium so that it's risky to put on a position at the front of the market: March MGEX at 90 cents over CBOT isn't cheap in any obvious way to me--there's no "edge." But if we look out farther on the futures curve, and consider KC wheat, then I think there is a trade. Dec11 MGEX is less than 10 cents over KC. The KCBT has adopted new storage rules (higher rates, especially from July through November) that may well make KC less attractive to hold than MGEX. And 10 cents is below the historical norm anyway.

So, even though there may not be as much volatility farther out on the curve, I feel there is so much less downside that I prefer to be positioned there.

Ethanol Views

I have posted a bunch of comments over at a blog called The Baseline Scenario . The blog was started by former IMF economist Simon Johnson and a grad school partner, so it's not exactly a leftist political blog-- more a centrist economic blog. Anyway, ethanol was mentioned in passing and I posted some comments on the relative merits of ethanol use versus imported crude oil...turns out it's a hot-button issue on any blog.

My impression from the comments there, along with past opinion pieces by economists like Paul Krugman, is that most people see ethanol use as "burning food" and contributing to world hunger. That's about as bad an image as a commodity can get.

Conservatives say they hate ethanol subsidies and Liberals say they hate them just as much. That leaves the Center and the Center isn't too crazy about ethanol either. While the blender credit will be renewed this time around, it may not survive a big, sustained rally in corn.

This is the "wall of worry" that ethanol will climb. With relatively low margins and precious little glamor, the business of ethanol production will struggle to find investors. Production growth will be slow. Producers will cut back quickly if margins turn negative, so prices will, at worst, follow corn.

This is a situation where two commodities are fairly tightly linked, but one is far more popular than the other. I believe that, in general, investor will do better buying the market where there not 500,000 other longs.

Done for the Year?

The recent trend where MGEX has strengthened versus KC and Chicago seems to have ended. I don't any screaming bargains there. I do like buying the March/selling the May in KC and Minneapolis wheat futures. Considering that the outright price still reflects substantially lower inventory levels from a year ago as well as strong global demand and also a not-so-strong dollar, I think buying March KC at almost 9 cents under May is an attractive risk/reward proposition. The downside: a 3 cent loss.

Posting here is going to be spotty through the holidays--especially if these calendar spreads are my only position.

I do also have the small long ethanol/short corn position, so hopefully, I will think of something worthwhile to write about there.

Trades I've missed:

As I noted in a recent post, I've spotted some good trade entries, but left the trades before the party really got going. But I don't lose a lot of sleep over getting out of an intermarket wheat spread too soon. I do kick myself for not buying MGEX seats more aggressively. The idea of buying cheap MGEX seats has been in the slogan box on this blog page since March. Being cautious in a falling market is fine. But missing the last two trades at $95K and 105K was not good.

I guess it's still 110K offered so there's not much harm done; but that's 15% higher than a month ago when the broader equities markets haven't moved all that much...

Apparently No Capacity Here for Long-Term Positions

Back after a week and I have none of the "long-term" positions that I put on back on November 29. All were winners right from the start and none have really stopped. So why am I flat?

Fear, mostly. Two of the three positions involved being short corn. The third, long March MGEX wheat/ short KC Wheat has added about 20 cents in 5 sessions; so while it's looking great, if the premise of the trade was a limited downside from 10 cents premium MGEX, there is now a lot more risk. With a USDA report due out, I don't really want either the short corn exposures or the newly hefty MGEX premium exposures.

One new position added today, on the smallest scale: long Jan Ethanol/ short corn. Ethanol calendars spreads have been in backwardation for most of the last few months, so I think the current inventories would have to be described as fairly tight. And these are the lowest ethanol crush levels in months. With sugar in the stratosphere and gasoline going on the up elevator with crude, it seems like ethanol could perform very well with any positive news at all.

Small Positions for the Vacation

I am taking a one week break.

I will take just a long March MGEX/short KC position with me (with a bit of tail hedge to protect against a further wheat rally). And a bunch of long March/short May calendar spreads in wheat, corn and oats.

I did not hold any December Oats into the Notice period, which of course, I regret. But oats was not the only futures market to see a spike in futures rolling off--there were moves in copper, coffee, gold...very interesting. Once the financial longs have done their rolls, supplies start to look a lot tighter.

KCBT Changing Wheat Contract Specs Starting September 2011

In a move that is intended to narrow the cash/futures basis, the KCBT will raise the "storage" rate for shipping certificates beginning next September. Additionally, they added a protein content requirement and lowered allowable vomitoxin levels.

I don't think these measures are certain to succeed. Raising the storage rate to 9 cents/month from July through December will help (up to 6 cents Jan-June), but it's not enough to change the current dynamic. If grains continue to rally, and I think commodities generally will, there will be increased interest from financial participants that will tend to push the futures higher than the cash markets.

To solve the convergence problem, the exchanges need to have huge penalties for deferring delivery (the CBOT is getting there) or adopt the MGEX contracts for settlement to a cash index. When you can't force anyone to take delivery and don't penalize them for deferral, there will be a strong tendency to very wide cash/futures basis.

SMall Trades for the Shorter Term?

On the long wheat/short corn trade I put on yesterday, the idea was to scale into a position as wheat traded down from 1.25X corn toward 1.2X corn. When wheat traded up today, I took the 8 cents and got out. I will still look to buy the wheat when it gets cheaper.

Small Trades for the Longer Term

Today I put on a few positions that I think will work out over weeks or months rather than days:
Long March Oats, short Corn.
Long March Wheat, short Corn.
Long March MGEX Wheat, short KC Wheat.

In the first two cases, we are above rock-bottom levels where feedlots would substitute for corn, but not by more than maybe 10%. Certainly there is at least twice that room on the upside.

In the second case, we see a similar set-up; there may be 15-25 cents of downside, but MGEX could easily be 50-70 cents over KC instead of the current 14-15.

The risk to all the above trades is a rampant bull market that attracts more speculation to corn and KC wheat than the less liquid oats and MGEX markets. A good offset to that risk would be to scoop up some calendar spreads at close to full carry, so I'll be on the lookout for that going forward.

Exiting Early

I am writing this wrap-up a little early because I have exited my intermarket MGEX/CBOT spreads. With the cash Hard Red Spring wheat trading $1+ over Soft Red Winter wheat, it looks like the March MGEX/CBOT spread has a lot of room to run from the current 65.5-67 cents. So I might be leaving this winning position too early--and I may eventually jump back in to go long the MGEX at even higher levels.

But this spread has had a 25 cent move over the last 10 sessions as the CBOT March contract has dropped a dollar. This kind of move cannot be explained as the impact of the VSR: too much, too fast, and no corresponding calendar spread moves. I don't think we are moving into a bear market with a lot of downside, so I don't want to depend on continued CBOT liquidations to pry the MGEX/CBOT spread to higher numbers. Rather, I fear that speculators will come back into the grains and the MGEX premium will (initially at least) get squeezed.

MGEX Premium Expands

One again CBOT wheat closed within a penny of the previous day, but today MGEX was up a nickel. I don't see any particular reason for it. Calendar spreads didn't move much on the CBOT or the MGEX. Perhaps there was some selling on the CBOT related to weakness in other markets like the S&P500 or corn or crude oil... It's nice to be the beneficiary of random moves, but it's not enough to get me to give up my long MGEX/ short CBOT position.

Another Good Day for ....Long Term Research

The wheat futures spent the day within about a nickel of unchenged for most of the day and intermarket and calendar spreads only shifted a penny or two.

So I begin to creep back into my usual long MGEX/ Short CBOT stance.

As wheat trades toward the low end of the range since the summer Russian drought, and corn is at the lowest levels since we found out yields would be lower than expected, I am looking for longer term bull market trades. Ideally that would be putting on a calendar spread around full carry just before the next harvest. I don't see that, but KC May10/July10 with a 6 cent discount for May (about 50% of full carry) doesn't look too bad as a bull market option. While wheat inventories aren't as tight as corn, you would have to pay over 20 cents premium for Sep10 corn over Dec10. If the grain markets soften, there is only a 6 cent downside on the wheat spread, but about 35-40 cents at risk on the corn trade.

Nick H., Fixed the Link!

Ethanol subsidy story link here.

I don't see where the study cited by DTN looks at competition from refined sugar markets. Interestingly, the study seems to pencil in the same "ethanol crush" margin in both subsidized and non-subsidized scenarios.

Animated Recap

Click here for animated recap.

Higher Quality Posts Must Be Just Around the Corner

I don't want this site to degenerate into daily market recaps. I have generally been long MGEX vs CBOT for some time and the daily moves are important because I would really like to make some money on them. But, generally, I would like to write more about the thinking behind the positions. In this most recent case I have been positioned in line with my belief that the high penalty rates for holding CBOT wheat (shipping certificates) will force the CBOT to a large discount to MGEX as delivery approaches.

This theory has generated excellent results except for the huge debacle that was the spike in wheat prices over the summer. (Other than that Mrs Lincoln, how was the play?) So to defend against that, I have tried to be more nimble and I have added significant "tail hedges."

At the moment, I have gone flat on the intermarket spreads. That's the nimble part. I believe that March MGEX will tend toward the 75 cent premium to CBOT we see now in December, but as the wheat futures bounce back up after a 15%+ sell-off, the MGEX premium may contract in the short-term.

One calendar spread I have on is long Dec10/ short March11 KC wheat. The MGEX and CBOT Dec/Mar spreads are both inside the cost of carrying the certificates, so I think there could be a late move in the KC spread toward 13 cents.

Trying Not to Overstay My Welcome

Wheat dropped along with other commodities today and the premium for March MGEX stretched to new highs. While I expect March MGEX/CBOT may eventually get as high as the current Dec10 spread (around 75 cents), it may take a while. So I pitched out 70% of my position as the premium expanded past 55 cents. I also squared up against KC.

Once again, the calendar spreads did not indicate a bigger surplus of wheat to store going forward. Instead, the calendar spreads flattened slightly. Once we get past the current QE2 driven volatility, the grain markets look poised for more bullish action eventually.

A Snoozer...

It was an exciting day in corn, or maybe beans, but all the March wheat futures finished within a penny of unchanged.

After liquidating intermarket spreads of oats and ethanol vs corn, I am back looking at those relationships again. Ethanol's backwardation has eased, but remains persistent. Ethanol inventories are still shrinking. There is a lot of uncertainty around legislation to continue the blender credit. Interesting situation which I think has more upside for ethanol than downside.

Looks Like Some Liquidations...

KC was hit the hardest of the three wheat futures markets, so I was able to take profits on some of my long MGEX/ short KC positions. Including the small extra long position as a "tail hedge," MGEX vs CBOT didn't move much at all.

Interestingly, the calendar spreads generally tightened--contangos flattened. There hasn't been any deterioration in supply/demand factors, grains just followed all the other commodities lower.

Ummm, No New Developments Really

Added a bit to long March MGEX/ short CBOT as it traded back to yesterday's levels. I think, all else being equal, that spread will trend toward the higher levels we see in the cash and Dec futures markets. The lower levels available out farther on the futures curve are due to the arbitrary levels set by the CBOT's VSR policy, not any anticipated difference in the economics of Minneapolis Spring Wheat vs Chicago Winter Wheat in upcoming months.

So Far, Not Good

While MGEX was steady to firmer against KC for most of the day, MGEX weakened throughout the day vs CBOT. While only yesterday I said that I was more comforable with the levels of the intermarket spread between MGEX and KC, today I felt compelled to put on a long MGEX/ short CBOT position. I am not willing to take much pain on this one though.

Also, I bought Dec/ sold March in KC wheat and CBOT corn anticipating a bounce in spread levels once the index rolls are done. Also dipped a toe in MGEX long Mar/ short May as that is 73% of full carry; so a limited downside and good potential if the wheat market turns stronger again. (As if $8/bushel isn't strong enough.)

Jumping Back into Wheat

Last week I got out of my intermarket wheat spreads fearing that the rush to commodities after the Fed announced QE2 would push the CBOT higher (against me). Today the wheat market, along with corn, looks to have reversed direction and started heading back down. So I am getting back in, sort of. Today I bought MGEX and sold KC. I believe this spread will be less volatile than MGEX/CBOT and I am more comfortable with the current level of the spread: I paid less then 8 cent premium for some Dec MGEX and only around 7 cents premium for some March.

I will be looking at the calendar spreads tomorrow as it is getting to the end of the traditional "Goldman roll." We may have already seen the biggest contango numbers for the Dec/March spreads.

Taking Off Early

No trading again. No values strike me as compelling. More speculators climbing into commodities--which is OK, I mean the Fed gave us all a strong push in that direction. And it is too soon to fade the speculators, so I'm reading and waiting.

According to the DTN/Progressive Farmer website, the KCBT is modifying its wheat contract's delivery specifications in an attempt to induce closer convergence at futures expiration. I don't see how raising the quality requirements for futures would make them less attractive or the physical wheat more attractive. When there is an enormous amount of financial speculation in a commodity contract, especially one where nobody ever has to take delivery of the physical, the futures will have to trade up to attract more sellers. As long as the market is at full carry and delivery is shipping certificates with a modest penalty for deferral, the cash/futures basis will be forced out to very wide levels.

Adding to MGEX Position, But Not in Wheat

Wheat traded up on, well, who knows why? QE2? Probably. CBOT gained ground against KC and MGEX as I feared it would if QE2 inspired a rush to commodities. Didn't gain a lot of ground though. I'm still flat.

Biggest trade for me today was paying the offer for an MGEX seat. I think they have cash and real estate of $45K/seat, leaving the trading business valued at $50K/seat. If ICE thinks the Climate Exchange is worth $600 million, I think the MGEX trading business is worth at least $20 million.

Liquidated Everything

Out of all calendar spreads, intermarket wheat spreads, ethanol and oats vs corn...everything.

All gone in the first half hour.

Most of my strategies are predicated on selling futures contracts that are the most popular with commodity indexers and speculators: nearby CBOT Wheat and Corn. But the Fed's QE2 policy is drawing more money into the funds that pump up the commodity indexes and supplying more firepower to speculators. For a little while, I will wait and see what happens.

More Hard Wheat Strength

Dec MGEX (72 cents premium) and KC (56 cents) improved to new highs for the season against CBOT.

I haven't commented much on calendar spreads since I got smoked on them over the summer. After taking my losses, I noted that I still thought that CBOT wheat calendar spreads would go to full carries as deliveries neared and that forecast looks pretty good today. My problem then (and still) is that the direction of the calendar spreads is correlated with the direction of the MGEX and KC intermarket spreads; so I have to pick where I would prefer to take my limited amount of risk. Anyway, the Dec10/Dec11 on the CBOT reached its biggest yet contango (111+ cents) while MGEX at 43 cents carry from Dec10/Dec11 is nowhere near the early July levels of 65 cents. Should the CBOT stretch to over 120 cents for a year, I think the risk/reward shifts sharply toward favoring a long front/short back month strategy.

Ethanol Trading Versus Corn

Ethanol continued higher against corn today. The Nov/Dec stayed close to 9 cents premium Nov and Dec traded at a similar premium to Jan. That's pretty tight: 7.5% premium to get ethanol 60 days earlier.

Looking out on the futures curves, that leaves March ethanol at very cheap levels against March corn (which is around 75% of full carry against Dec10). Maybe it should be cheap, but it looks like there is not enough refining margin going forward to inspire producers to bring much new capacity into operation...so how will the current ethanol tightness be alleviated?

Still Waiting...

Still long MGEX vs CBOT in Dec and March. Long Dec MGEX vs KC. Maybe Dec MGEX at a dime over KC is a fair price, but Hard Spring Wheat cash is at least 75 cents over Hard Winter Wheat. Could the cash basis for KC stay 65 cents weaker than Minneapolis? Sure. But I don't know why that would be a great bet. Plenty of wheat in storage at both locations.

Big news week coming up, but the Fed news will be out after the pit close Wednesday, so I don't expect we will see major direction in the market 'til Thursday.

Hard Wheat Strength

Late this week, both MGEX and KCBT Dec Wheat futures closed at the best levels of the year with the exception of one day, the August 5 spike. The CBOT wheat finished around its average level for the period since August 5. So the MGEX is pushing 60 cents premium to CBOT while KC is over 50 cents premium. I like it and I think KC and MGEX especially will continue to outperform the CBOT.

If we look out to Dec11, we see MGEX wheat priced at even with to CBOT and KC at a discount--does anyone really think that is how they will settle in a year's time? No. That's where the high VSR charges force the forward curve. I'm happy to buy the hard wheat futures vs CBOT and wait.

No Trading Today

MGEX wheat was the best performer on a continuation of the wheat rally. Commercial demand? Noise? Who knows...

No shortage looming for Dec CBOT as that stayed a full 39 cents under March. Correct me if I'm wrong, but all the grains from Corn to Wheat to Oats are at 80%+ of full carry. This is a striking contrast to markets like sugar, cotton, cocoa, ethanol, gasoline, milk... Taking corn as an example, I think bulls can take comfort in the low stocks/use ratio and attribute the nearby spreads to a function of the US (vs world) harvest and storage situation and pin hopes on the shape of the more deferred futures curves which bends towards backwardation.

Outside of the wheat market, next week's Federal Reserve actions/announcements could have a big impact on all commodities. Personally, I can't imagine a Fed Chairman whose entire career is built on the idea of expansionary monetary policy disappointing markets on the scale of QE2. Should investors rush into commodities, we could see CBOT gaining more than the less actively traded KC and MGEX--just something to bear in mind.

Rolling to March

I am happily rolling Dec MGEX longs and Dec CBOT shorts to March. Maybe I should hang in for another week or two, but with the CBOT Dec at 39 cents under March, there's only a couple more cents there at best. The March11 MGEX is around 30 cents premium to CBOT; no surprise that I think that's a bargain with the Dec at 54-55 cents premium and cash Spring Wheat at around 90 cents premium to Soft Winter Red Wheat.

Yesterday, I bought March/sold May in Corn. I figure there's only 6-7 cents downside and these spreads may come in handy if (when) grains spike to new highs. I will be on the lookout to buy March/sell May in Oats if I can get that close to 10 cents discount for March.

Not Such a Great Day

MGEX lagged more and more as the grains were pushed higher. Obviously I'm the wrong guy to ask about why CBOT wheat was 20 cents more attractive by the end of the day. Some of my Dec MGEX I sold out vs CBOT, but some I held and some I rolled to March.

As I mentioned yesterday, there is pressure on the front of the CBOT market and there isn't that much more room for Dec/March CBOT to run... even with the VSR hike Dec/March will only be 40 cents plus financing-which could be anything from zero to four cents. So I rolled from long Dec MGEX/ short Dec CBOT to long March MGEX/short March CBOT at 24.5 cents cheaper. If I can pick up 25 cents every 3 months on that spread, I will be long MGEX at $1.50 under CBOT by this time in 2012...

Grains Hoisted Higher

On a day when broad commodity indexes like the old CRB (now called the Continuous Commodity Index) posted gains over 1%, CBOT wheat stayed within a few ticks of unchanged for the bulk of the day. The premium for Dec MGEX over CBOT stayed up near 58-59 cents. I continued to add to that position today. The difference between the Dec10/Dec11 carries for CBOT and MGEX continued to increase-stretching to over 60 cents at the close. The differences in the carries can manifest themselves in a variety of ways, but I am betting that there will continue to be a lot of pressure at the front end of the CBOT market.

I am also long both Dec Oats and Ethanol vs corn--looking forward to earning as those positions roll forward, particularly on the ethanol which is in backwardation.

Markets Unchanged, Nothing to Post

Marking Time in Wheat

Didn't trade. Stopped watching the market around 11:15 in NY. Glanced at the final 15 minutes.

Spent some time mulling over how the MGEX seats are the same price as the first half of 2009. I assume the Exchange real estate operations are struggling-perhaps worse than the overall Minneapolis commercial market. But as CME shares move back toward $300 and ICE shares push toward $120 (if ICE liked Winnipeg, they should love MGEX), these seats seem very cheap. I think we are only about a month away from the KCBT setting their dividend for the year--over $20K/seat last year. Over a 5% yield on the $390K last trade. Now if only the MGEX had a $5K annual dividend....

Why Don't We Just Buy Corn?

Really, I don't do very much outright speculation and I am not going long here. In fact, I did get the chance to buy Dec Oats at 62.5% of Corn. I do this with very low leverage because I plan to stay in long Oats/short Corn unless Oats drop to below 55% of Corn. So that means I have to be prepared to lose 40 cents/bushel if corn really spikes up. I am also short Corn against long Dec Ethanol.

With Dec CBOT wheat below 1.2X corn, we are getting into an area where corn is going to have to lift the entire grain market to move higher--and that's in addition to corn already carrying the weight of large commodity index longs and large trend-follower longs. That's a lot of weight to carry.

The wheat futures were uninspiring by comparison. Dec MGEX approached 60 cents premium to CBOT which was a strong showing in an up market. In a move I may regret, I let go of the long Dec11 MGEX vs CBOT at around even. That Dec11 spread has been in a 5 cent range for a month, so hopefully, I'll get a chance to get back in with MGEX at a discount.

Typical Down Day Dynamics

Speculators lightened equity and commodity positions today. Wheat traded down in line with most other markets. CBOT dropped a few cents more than MGEX or KC. Calendar spreads for the more distant months went to steeper contango. Even though the overall direction was down, the Dec11 wheat contracts were well bid with standing orders to buy every penny down on the MGEX.

A big sell-off in oats brought them back to less than 63.5% of corn. I will be looking to buy them if they drop another couple of percent on that ratio. The 300 lots of Oats that traded in the last 10 minutes appeared to be 10% of the non-commercial longs getting out. Corn, on the other hand, traded up 3 cents in the last 10 minutes without notable liquidation pressures.

KCBT Not Moving to VSR...

Apparently defying the CFTC's wishes, the Grain Service newsletter reports that the KCBT is instead considering a rise in storage charges to 6 cents/month with a seasonal 3 cents/month surcharge from July through November. The KCBT wheat contract committee expressed concern that a change to VSR could negatively affect liquidity; this fear has been addressed at the CME in this study which was published back in July. To my knowledge, the MGEX has not considered any changes to its 5 cent/month storage rates.

Dec MGEX moved to the highest level since June against the CBOT trading at a 53-55 cent premium for most of the day. A couple of cents of today's move was due to the steepening of the CBOT contango relative to MGEX. Intermarket spreads further out, say in Dec11, didn't move from recent ranges.

Consolidating Near the Highs

MGEX Dec wheat spent the day in a narrow 1% trading range that was well within the same range we have seen since the surprising USDA report last week. Looking further out at Dec11, we see the CBOT wheat contract consolidating close to its summer highs of $8/bushel; while the Dec11 MGEX is about the same $8 price now, that is above the summer highs for MGEX.
It will be interesting to look at the CFTC COT report. It would be a more bullish scenario if non-commercial trend-followers weren't holding such large net long positions.

Stepping Back In...

It seemed riskier to be out of the Dec MGEX/CBOT spread than in it. So I jumped back in buying the Dec MGEX at about 50 cents over CBOT and also at around 10 cents over KC. Don't forget to buy a little extra on the long side as a "tail hedge" against the risk of a rising grain market spurring the CBOT to narrow the spread.

I believe that at normal to lower-than-normal premiums for MGEX over CBOT that it will pay to own the MGEX contracts as the CBOT contracts will be subject to increasing VSR contangos. Already Dec/March is 22 cents more expensive to carry on the CBOT. There is every indication that full carry on the Dec/March CBOT will be around 43.5 cents--about 27% annualized to carry CBOT wheat.

Stepping Out of MGEX Wheat for a Moment

On today's pullback in the wheat market, we saw the Dec MGEX contract trading back up to the 47 cent premium level vs the CBOT. While I don't see this as overpriced at all, it does seem that there has been pressure on that premium as the grain markets have rallied over the past couple of weeks...so I went to flat.

Bids have come into the MGEX membership market, with 2 bids coming in over the past 2 days at levels above the last sale. One of those was mine. Don't know if this is related to the Board election results--though it is unusual for an incumbent not to be re-elected to most boards.

Reviewing Some Bad Calls....

Before the huge run up in wheat prices this Summer, I used to point out that wheat was cheap at below 1.3X corn, but what with the big wheat inventories it would likely get cheaper. Of course wheat sky-rocketed to about 2X corn, but funny enough, it is all the way back down to 1.25X corn. Interesting. Cattle don't usually get to eat bagels...

Another swing and a miss related to this corn rally is my call on buying ethanol vs selling corn. Even though the ethanol market remains very tight, continuing to trade in backwardation in the nearby months, ethanol was not at all able to keep pace with corn today. While I still like the trade, I have scaled back my position size (at a loss) due to the higher volatility.

And on a final note, I also reduced my position on long Dec MGEX vs CBOT--again, I like the position, but want a smaller size due to the higher volatility in grains.

Godot Arrives...and He's Buying Grains

I guess those USDA numbers were surprising. I was surprised by the reaction. It looks like there are people willing to get long at these higher levels. Hope it works out for them.

The hard wheat futures didn't quite keep pace with the CBOT, but it was pretty close. Even with the tighter grain inventories and the new highs in Corn, the grains are not going to get much ink from the press since other commodities like cotton, tin, gold and others are all making more stunning moves higher at the moment. Unlike this Summer, the grains will have to see actual demand eating into inventories to keep the rallies going. That said, the fundamentals do look positive. My thinking is that the next leg of the rally in wheat will see stronger performance from hard wheat futures relative to CBOT than we saw on the first leg this Summer.

Waiting for USDA....

Feels more like Waiting for Godot, but unlike the title character in the Beckett play, the USDA report will actually arrive tomorrow. My approach to most news releases is that they are unimportant with regard to fundamental supply/demand information, but revealing with regard to traders' positions and inclinations. My bet would be that the large speculative long positions in grains (especially Corn) will come under further pressure.

I was nervous about holding my long Dec MGEX/short CBOT today as it was very steady at lower levels-no sign of bargain hunters at 45.5/46 cents over CBOT. But the relatively strong MGEX close and the prospect of some CBOT liquidations tomorrow gave me the incentive to hold on for a bit longer. We'll see how that turns out...

Adding a Little Bit Here and There...

MGEX just about kept pace with the rally in CBOT wheat today; the Dec spread spent the majority of the day at 48-49 cents premium MGEX. I added to the "tail hedge" on concern the massive rallies in other commodities would spill into wheat. On the intermarket spreads, I added out in Dec11 where it was possible to pick up MGEX at 5 cents discount to CBOT.

The DTN cash index for Spring Wheat is around 75-80 cents premium to Soft Red Winter Wheat, so I am hoping for at least that kind of number for the Dec10 MGEX/CBOT spread eventually.

No New News Today

Recent trends continue in wheat-outright prices lower, calendar spreads move toward steeper contango, CBOT liquidations drive intermarket wheat spreads to bigger premiums for hard wheat futures.

Ethanol is recovering versus Corn. The combination of higher Crude/RBOB Gasoline and Corn under pressure from speculators liquidating long positions has helped Dec Ethanol impove by about 7 cents/gallon over the last few sessions. Not too shabby, but I think there could be a lot more upside to come.

Dec MGEX Irresistable

Like a moth to a flame, I am drawn back to long Dec MGEX, short CBOT.

Also, while I never did get back into long Oats/ short Corn, I was able to buy Dec/sell March Oats at better than a 9 cent discount for Dec today. The downside on this is about 7 cents and there is little in the way of commodity index rolls or long speculative positions to drive the spread to a big discount for Dec.

Thoughts on MGEX Election?

I would love to hear from members and non-members on the subject of the MGEX Board election.

Flat in Wheat

Well, almost...I've bought a couple of contracts of Dec11 MGEX at a small discount to CBOT. While it seems like the unwinding of speculative positions would hammer the CBOT harder than the MGEX, that hasn't been the case over the past couple of days. Possibly it's because the Dec10 MGEX was almost back to the June highs versus the CBOT--who knows. Should the liquidation by trend-followers intensify, I think the MGEX will strengthen relative to CBOT.
Also, with the cash Spring Wheat at a premium to Soft Red Winter Wheat (70+ cents) and the VSR forcing convergence harder on the CBOT cash/futures basis, the MGEX premium could grow rapidly toward Dec expiration--perhaps up towards $1.00...just an idea.

MGEX Slipping vs CBOT

In spite of a drop in the outright market for wheat, CBOT was the strongest performer of the three wheat futures. Seeing from the open that the market had the potential for a big down day, I tried to be patient and hold my long MGEX/short CBOT position waiting for the trend-followers to dump their CBOT wheat. Didn't happen that way--and in the end I liquidated more of my position though not all.

The price action was very negative for both corn and wheat. Corn started at new highs, but finished down for the day. Dec wheat stayed above $7, but not by much; there was no sign that anyone in the market saw this level as a screaming bargain. With the CFTC COT report showing continued high levels of long positions among trend-followers, this bull market in wheat needs to move forward or we will see some liquidation.

Not Pressing Anymore...

The relentless climb of Dec MGEX vs CBOT halted today. After the debacle this summer, I don't have much appetite for fighting a bull market on the CBOT. So I lobbed out some of my Long MGEX/Short CBOT position today and will pitch the rest out Monday unless there is some change in direction.

While I would like to be selling Dec MGEX at the 75+ cent premium the DTN cash market shows as the premium to cash Soft Red Wheat, it does look attractive to replace the Dec10 MGEX/CBOT spread with Dec11 spreads. Dec11 MGEX continues to trade at a small discount to CBOT.

Cheap Ethanol Getting Cheaper Relative to Corn

Maybe I shouldn't comment on ethanol: I don't much of anything about the physical market, don't know any traders or producers or end-users. I don't know how California regulations affect demand for 2011 and beyond. Don't know what blender credit legislation may or may not be passed before year-end.

A market that is tight enough to be in backwardation for months doesn't seem likely to be the same market that is priced so that producers lose money and shut down. Yet I think that is what we are seeing with October contracts still trading at a premium to the rest of the calendar, while simultaneously the December contract is at the cheapest levels seen in years vs Dec corn.

I'm losing money on this trade, but I still like it.

Pressing Again (Golf Lingo)

Unlike a partner in a round of golf, Mr Market lets you press your bet (increase the wager) at any time. More Dec MGEX wheat/less CBOT.

This is an easy trade in a bear market. The key question is whether MGEX will outpace-- due to export demand-- when the wheat market turns higher.

Bullish News...Grains Struggle

After sharp gains overnight and a generally bullish commodities environment this morning, wheat trended down all day. It seemed like the price action one might expect with a lot of speculative long positions. Perhaps more ominous for bulls, the calendar spreads moved sharply toward contango as well. I'm not reading that much into one day's price action. Dec MGEX continued to strengthen against CBOT--I am rebuilding my long MGEX position there with a small extra gearing to MGEX to help guard against a bull market on the CBOT crushing the MGEX premium. Traded around corn calendar spreads ending up with a long March/short May position --also intended to protect me on a sharp move higher in grains with a limited downside if the outright market falls.

KCBT Moving to Adopt VSR

Thanks to comments from BMH, and no thanks to the KCBT, we know that KCBT's Wheat Contract Committee has recommended moving to a Variable Storage Rate mechanism similar to that on the CME. A google search shows this news conveyed by both National Grain and Feed Associationand grainnet.com--though neither cites a source. I think the grainnet.com summary is not quite correct on the details of the existing CME VSR, and the KCBT plan may change as it goes to the Board and then members for approval, but it looks like it will happen.

I continued to liquidate my Dec MGEX/CBOT wheat spreads as the overall market threatens to burst higher-now down to 50% of previous position. In the cash markets, the Spring Wheat index is pushing up toward 70 cents over Soft Red Wheat, so I am reluctant to exit at these 33-34 cents premiums for Dec MGEX, but it's nice to have more flexibility if the intermarket spread is volatile.

Patience Has Its Limits

After mentioning how patient I've been with the Dec MGEX/CBOT wheat spread, I was happy to let about a third of my position go today at the best levels since the late June surge of CBOT wheat prices. Of course, by keeping 2/3 I'm indicating that I think there are likely higher levels ahead--though not as confidently as before.

While the rallies in corn and cotton look like they are due for at least a correction, the rallies are not confined to ags. With gold making new highs and the dollar trending lower, the overall climate is very bullish for wheat prices. Despite the high levels of non-commercial longs (speculators), I fear another push higher on the CBOT wheat contract. The early August spike over $8/bushel probably marked the highs for many months, but the pain lingers on...

Trading MGEX vs CBOT Wheat

Over the past 6 months, it appears that the biggest factor in the intermarket wheat spreads has been the direction of the outright price of wheat. I'm not really looking for a way to speculate on the outright price. So what I've been looking for is ways to mitigate the effects of "directional" moves in the wheat market on the intermarkets spreads I am holding.

Over the period, the CBOT has clearly been more volatile; the obvious answer then is to underweight the CBOT position vs MGEX. And I've been doing that recently. Less obvious would be to buy a few outright CBOT wheat calls against the CBOT short position.

Another strategy may be to balance intermarket spreads with calendar spreads likely to hedge an adverse move in the outright market. For example, while Dec CBOT is more volatile than Dec MGEX, the Dec MGEX is more volatile than the July CBOT--so a long Dec MGEX position is more neutral against a basket of Dec and July CBOT than against a straight Dec CBOT hedge. At this stage, I find any long front/short back month spreads in CBOT wheat to have too much downside as they move to full carry. My solution, for the moment, is too substitute a long Dec/ short March Corn spread as a general hedge against a spike in grain prices that still has a very small downside.

Too confusing? Poorly thought out? Any comments?

Let's Play Jeopardy!-- Category: Oats Trading

Alex, I'll take Bad Trades for $1000.

After saying I would hold on to my long oats/short corn position, I dumped it on the opening today. Later in the day, I tried to get back as oats and corn traded up, but I never paid up enough.

One place I have been patient is in the long Dec MGEX/ short CBOT trade; both the MGEX and the KC futures continue a pretty steady climb against the CBOT. With the Dec MGEX at a discount to KC, I still like being long the MGEX the best. Cash Spring wheat is trading a full 60 cents over cash Soft Winter Wheat, so the 27 cent Dec MGEX premium to the CBOT still seems conservative.

The Dec ethanol contract looks like a fantastic bull market...but it's not quite keeping pace with Corn. Not losing much, but barely keeping up. I like holding the long Dec ethanol/ short Corn at these levels and would like to hold through the gov't rulings on raising the blend wall to E12 or E15...

Tough to Be a Bear

The latest CFTC COT report shows continued growth in the lopsided long position of trend-followers and indexers alike. And yet, still they buy more.
The demand pull looks good. Supplies not so onerous. Apparently nothing but blue skies and higher prices ahead.

Since my last mention of Oats, they have rallied to around 69% of Corn. I'm holding on for more.

A Link for Nick H

CME Ethanol Outlook Link

The Ethanol Crush is Page 14. Although it isn't labeled as such, the chart appears to be a rolling futures chart with the most recent price drop due to the premium Sep Ethanol contract being replaced by a lower priced new contract and the Sep Corn being replaced by higher priced forward Corn. I made a few comments on this in the Comments section of the previous post.

No Real Surprises on this Wheat Rally

The CBOT outperformed on the upside, but not by a lot. I have added some some "tail hedges" over the last few days; I own a few more MGEX longs than I have CBOT shorts. This pretty much neutralized the adverse intermarket spread move for the day.

In addition to buying Dec/selling Mar in Oats, I have also added a similar spread in Corn. While I'm not enthusiastically bullish about corn (primarily because of the large non-commercial long position), there is so little downside on this calendar spread, I think it is worth a shot.

MGEX Membership Prices

A recent sale of a KCBT membership led me to look at some historical comparisons to the MGEX. Last week, a KC seat traded for $390,000--a price about 2.5% below the September 2008 price and 46% below the all-time highs of Dec 2007. MGEX's last sale was 33% below the prices of September 2008 and fully 72% down from the highs (Feb 2008).

To be fair, the MGEX membership price performance is not much worse than the shares of the CME which are about 28% down from September 2008 and 63% down from the highs. ICE shares performed significantly better, at least recently; they are up 20% since September 2008.

So either the MGEX has been relatively poorly run over the past several years or the seats are dang cheap-take your pick.

**PS. My back-of-the-envelope calculation is that the MGEX would have to start paying a dividend of approximately $6,000/membership to "catch up" to the KCBT seat performance. More realistically, a dividend of $4,000 would provide solid support for membership prices and stop the decay in value.

Back to Full-Time Trading

And greeted with the dullest day in month...

The MGEX Dec futures continue to stay firm relative to the CBOT -- over the last 7 sessions, wheat has rallied about 40-50 cents while the Dec MGEX/CBOT spread has held at about 17 cents premium MGEX.

On the calendar spreads, the futures are pricing in significant changes ahead for wheat--apparently all the wheat in storage is going to be pulled out very rapidly after December (or its owners will happily pay a premium for the privilege of storing it). I am looking at corn, beans, and oats trading at close to full carry for Dec/Mar and I think they are all more attractive than betting on further backwardation in wheat spreads. So far I have only pulled the trigger on a small number of oats spreads, but all look like reasonable protection against a sudden move up in grain prices.

Minneapolis Wheat Upward and Onward

Interesting that the MGEX wheat has outperformed CBOT recently--even on days when the overall market is up. DTN cash index prices have HRS at 60 cents over SRW and there appears to be little export demand for the CBOT product. Dec MGEX at only 21 cents premium still looks like a bargain to me.

Oats Revisited

After the big move up in June due to Canadian weather, Oats have fallen off the radar. The low plantings numbers from Canada caused the trend-following shorts to cover oats well before the Russian drought forced shorts out of every other grain. So for the past several months, Oats have been sliding down in relative value versus Corn. I am an infrequent visitor to Oats and just look to buy them at around 50% of Corn. Since the oat market may be a bit tighter than usual, and since the trend-followers have loaded up on Corn, I've decided to stretch a bit and buy Dec Oats/short Corn today with Oats at 63% of the Corn price. I should do even dollar amounts on each side, but with the small amounts I am executing, I had to buy a little more oats than I shorted in corn.

Whither Dec/March Calendar Spreads?

Is there any way that Dec/March won't be at a full carry on all the exchanges eventually?

While the MGEX Sep/Dec tightened a dime over the course of August, to less than 5 cents/bushel--and 10 cents less than the cost of carry, KC and CBOT spent much of the month at around the cost of carry. And it was a big 31+ cent carry on the CBOT. And these carries were at a time when wheat has stayed at prices around 50% higher than 3 months ago.

What kind of bull market would it take to prevent the Dec/March (and further out spreads) from falling to the same full carry?

Light Posting Due to "Vacation"

Still maintaining positions and following the markets, but won't be back to regular postings for a week or so...

Reading up on some research reports (hat tip to BMH), I was struck by the lack of understanding of the CBOT's new VSR (variable storage rate) regime. Even top research professionals seem confused by some of the details. For example, while the storage rate increases are triggered by spreads averaging over 80% of full carry (within a certain time period), storage rates do not drop if the spreads are under 80%--the spreads have to be below 50% of full carry (during the appropriate time period) to trigger a drop in the storage rate.

With CME shares down almost 30% so far this year, I guess they have other things to worry about besides publicizing an obscure delivery rules change, but still...

More Bear Market Dynamics

We saw wheat down 15-20 cents for most of the day and the intermarket spreads and calendar spreads responded predictably: MGEX Sep wheat strengthened to 42 cents over CBOT while calendar spreads drifted towards steeper contango. While we are mostly trading Dec wheat, I note the Sep level because as that spread collapsed in the "Russian spike" I thought we would see it return to 75 cents premium--we may see it yet. Of course, that doesn't really matter if you've stopped out at lower levels, but it's still worth noting. Note also that the Sep/Dec spread is very tight on the MGEX and it makes the Dec MGEX at 12 cents over CBOT look pretty attractive.

Ethanol still very strong with Sep at 9-10 cents over October and at a premium to Sep RBOB gasoline. While ethanol looks pricey vs gasoline, the nearby month strength and cheapness vs corn make it an attractive buy out toward the Dec contract.

Some Speculation on Ethanol

With all the action in wheat, the ethanol market has not received much attention. But an interesting situation has developed: The front month, September, is trading at 9 cents (5%) over October. Inventories are stable. Usage is declining as the summer driving season draws to a close.

Ethanol inventories nationwide were at similar levels when I took delivery just last Spring because the front month was at a 3 cent discount (yielding 3.75% annualized on cash for a month). Demand for ethanol rises through the summer with gasoline demand, but August averaged only 3 cents over Sep--and that seems high.

So either there is a localized shortage at exchange delivery points or there is a real market anomaly here. If there is not a localized shortage, that would indicate to me that there is speculation on a regulatory action raising the 10% blend wall. I'm looking into the exchange inventory situation...Meanwhile, I bought some Dec Ethanol vs Corn.

Short Day

I have been trying to add to the intermarket position, long hard wheat vs short soft, as the market has settled a bit over the past 2 weeks. The levels are not as attractive as they were in the peak chaos during the first week of August, but there is, perhaps, a smaller chance of being forced out of the position. I still favor the intermarket spreads as being more less directional than the calendar spreads, at least from now going forward.

While I do not have a crystal ball to predict Russian weather, I think wheat market participants will look back at this summer's run-up in prices and see them as primarily technical (large non-commercial short position in June) and political (Russian domestic decision to suppress exports) rather than driven by physical supply and demand.

Wheat, and Wheat Spreads, Bouncing

It didn't take much to get the calendar spreads like Dec10/July11 moving back to backwardation. July wheat was up about 3-4% on the day, which is about the price variation we see now in the first 15 minutes of trading on the CBOT, and that was enough to convince the market that buyers would pay a premium for the privilege of holding wheat in storage for 7 months. Hmmm, we'll see how that works out for the holders of CBOT shipping certificates for the period.

On the intermarket spreads there was much less movement. KC and MGEX are both holding slim premiums to CBOT so far through this 2 day rally. Since the wheat rally is based on the idea of huge US exports to North Africa/Middle East, it will be interesting to see how much export "pull" there is on cash Soft Red Wheat. The DTN cash indexes for Hard Red Winter Wheat and Hard Red Spring Wheat bottomed out vs. Soft Red Winter Wheat in the first week of this month and have since rallied about 40 cents on the spread. Yet with HRW still 30 cents under SRW, it still looks cheap.

The argument for the relative strength of SRW in the cash market was that it was being held back by the high storage rates implied by the CBOT. With the CBOT now having swung all the way to backwardation for Dec10/July11, it is hard to see why SRW should command a premium in the cash market as the implication is that the SRW will come out of storage.

Waiting for the Ukrainian rain.

Not much to talk about today...

Will see how things look tomorrow with the rain falling in Russia.

Same Post as Yesterday, More Steps Back toward Rationality

The relative value spreads have traded back to levels that are no longer insane. There may be a lot of room left, but Dec10/July11 CBOT is back in contango; MGEX is premium to CBOT all along the futures curve. Both that calendar spread and the that intermarket spread may have another 50-60 cents in them, but they are back at levels that are economically plausible in some scenarios, however unlikely.

Not knowing if or when the CBOT may rally again, I've reduced exposure--liquidating calendar spreads and paring down the long MGEX/short CBOT position.

More Baby Steps...

We saw a continuation of the bear market dynamics: CBOT leading the declines ahead of KC and MGEX, and the contango reasserting itself in the wheat futures. The spreads are all highly correlated to the outright price moves. So we all wait to see when in rains in the plain in the Ukraine.

In related investment areas, the MGEX seats have continued to move lower in price--from over $100K at the start of the year to $80K last week. In light of their move to for-profit corporate status and enjoying high volumes and open interest, this seems odd until one checks the price moves of the CME, ICE, and the recent IPO of the CBOE: all are down 13-30% year-to-date. So the decline in MGEX membership values is broadly in line with the declines in other exchange valuations. Personally, I still like owning it.

Lastly, I've been looking at the valuations of exchange-traded farmland MLPs (master limited partnerships) and comparing them to the values in the $180 billion market for listed energy and pipeline MLPs. Oh wait... there aren't any listed farmland MLPs. More on this topic in days to come.

Another Baby Step Back

Hard wheat futures outperform again: MGEX and KC spent most of the day in the plus column while the CBOT was mired in red. Everything sold off at the close to finish lower. Also the calendar spreads moved back toward contango--all the spreads are still at highly elevated levels from full carry, but air is leaking from the pumped up levels we saw last week.

Forecasts for Russian weather now include the possibility of rain...someday. If they get some rain in the next couple of weeks, the hype of a ruined 2011 winter wheat crop will fade. Last week's CFTC COT report did not show a big increase in non-commercial longs; I will be checking to see if they show up in tonight's report. If we see a long of new longs at these price levels with the headlines become less supportive now, the market could drop very quickly.

We Are Still a Long Way from Normal

In recent posts I have mentioned that the smaller CBOT Dec10/July backwardation and smaller premium for Dec CBOT over MGE as steps towards normacly. Still, does anyone really think that May11 CBOT will go off the board at a premium to July11? Or that Dec MGE will end at a discount to CBOT?

We are still in a period of chaotic pricing for wheat futures, with unsustainable price levels in a whole variety of relative value spreads.

No Trading Today

Another Step toward Normalcy

Again today, as wheat prices declined modestly (15 cents) calendar spreadsmoved away from backwardation and hard wheat futures rose to a premium to CBOT, at least in the nearby futures.

While I speculated last Friday that the top may have been put in for this rally, I was very surprised to see the small addition to non-commercial longs in the CFTC COT report that came out after the close. This is worth watching, as is the cash/futures basis, in order to spot signs of commercial demand. Surely, the drought in Russia is very serious; the question was always about how much impact it would have on inventories.

Creeping Back to Sanity

While outright prices in wheat stayed elevated, both the calendar spreads and intermarket spreads moved back toward more sensible levels. The CBOT backwardation from Dec to July11 dropped from over 50 cents to under 30 cents. Of course, with the nearby CBOT Sep/Dec trading at a 30+cent contango, and the VSR storage rate poised to jump to 11 cents/month, it's still hard to imagine Dec staying anywhere near 30 cents premium for long. Similarly, on the intermarket spreads KC and MGE were about 10-15 cents stronger than CBOT for most of the day. Since the Russian drought does not in any way favor CBOT wheat over the hard wheat futures, there should be a lot more upside for KC and MGE against CBOT.

Was that the Top?

After pushing limit up overnight, wheat futures finished limit down. Calendar spreads that went to huge backwardation, like Dec10/July11 at over $1, also settled lower. The intermarket spreads were a bit harder to judge; after Dec MGE traded at over 35 cents discount to CBOT, it rallied to within 15 cents of the CBOT, but drooped again toward the close.
On the intermarket spread, in one sense there is less risk being long MGE at 20 cents under CBOT than at any kind of premium--the fundamentals are more favorable. But sadly, in this higher volatility environment, I will be taking smaller positions and not larger. So we dip a toe back in, long the Dec MGE vs CBOT.

Futures Unbound

The wheat futures continue to skyrocket. Cash markets, not quite so much. The CFTC reviewed the KCBT convergence problem --futures are a full $1.50 over cash even before today's rally--and declared that, someday, somehow, they should fix that. No particular deadline.
http://www.reuters.com/article/idUSNLL5JE6BE20100805

So with Russia and Ukraine deciding to tear up their contracts, and the US futures only loosely tethered to the cash markets, we have a recipe for fantastic futures market volatility. Eventually, it will rain in Russia; Russia will get back to marketing their surplus wheat; hard wheat will trade at a premium to soft wheat. But not today, and not likely tomorrow either.

Taking a Breather...

Well, I've had enough. For now, anyway. Dec CBOT traded to a strong premium to both KC and MGE throughout the day. While there are many signs of a short-term top in wheat, and few reasons to be long-term bullish on CBOT's soft wheat vs hard wheat futures, it's is impossible to predict how far, exactly, a market will spike.

So, for now we go flat.

Just for simplicity, I also sold out of ethanol vs corn, which has been fairly stable.

The world has gone mad today
And good's bad today,
And black's white today,
And day's night today...anything goes.
C.Porter

Even on a Down Day, the CBOT Wheat Outperforms

While there was a lull in the bull market in wheat prices, Dec CBOT Wheat pushed to almost 10 cents over KC and pulled almost even with MGE. The cash market for Soft Red Winter Wheat (CBOT) is also at the smallest discount to futures. The explanation for the relatively strong cash price has been that since the CBOT had by far the steepest contango, soft wheat was being stored instead of sold. With the recent flattening of the forward curve, along with the current strong cash price relative to futures, that soft wheat should come back out into the market. We'll see.

It seems the market is expecting only a small reduction in world inventories in next week's WASDE numbers from the USDA. This may not stop a rampant bull market, since the supply increases may be concentrated in non-exporting nations such as China. So if large inventories won't even counteract the "shortage," there may be no stopping a further rally in CBOT prices, both outright and vs KC and MGE (and even tulips).

Big Dislocations

Reading the Grain Service newsletter, which advises that the Russian drought is very serious and will have continuing impact, you see a forecast of grain storage overflowing in the US this fall (with big corn and bean harvests) alongside a recommendation not to take advantage of nearly flat spreads from Dec10 through July11.

They may be right, though I doubt it. If the glut of grains, including wheat, prices itself into world markets via big and variable discounts in the cash/futures basis, then I guess it's possible. Far more likely is the scenario where the nearby spreads go to full carry while back-month spreads fluctuate even into backwardation. There just isn't much risk capital devoted to trading along the wheat futures curve. As time goes by, the spreads will, one-by-one , go to full carry.

It should be noted that at this point in this bull market, nobody is paying up for cash wheat. Rather, physical wheat is trading at ever great discounts to futures. This may be highlighted in a CFTC review of cash/futures convergence on Wednesday.

Calendar Spread Shockers!

May/July CBOT Wheat at 5 cents premium May?

If Russia produced no wheat at all this year, I wouldn't expect May to go to a premium. More realistically, I wouldn't expect May to finish at a premium to July. Markets can go anywhere, but they can't stay there. Of course, the CBOT outpaced both KC and MGE to the upside, but only by 2-4 cents on a 30 cent move up in the outright price. Not by the 11.5 cents that Dec10 CBOT moved up against July11.

The CFTC COT report will be interesting: if there hasn't been a continuation of non-commercial buying, then I must be very wrong. As long as the non-commercial pour into the market, we will keep going...

Some Thoughts about Timing

Through this tremendous rally in wheat prices, I have been managing strategies that seem better suited to bear markets. First, I have been buying Minneapolis and KC wheat futures vs shorting CBOT futures on the theory that commodity index buying pushes the CBOT higher than commercial values will support. Second, I have shorted nearby CBOT futures vs buying more distant contracts on the theory that with a sufficient current wheat inventory, the commodity index rolls will consistently push the calendar spreads toward full carry (or better, the VSR maximum).

As the market has rallied, ostensibly on the news of lower production from non-US sources, both strategies have suffered significant losses. I chose to reduce risk by eliminating positions on the calendar spreads, because on the slim chance that the Russian drought has a significant impact on supplies, the calendar spreads should be directly affected. I kept the long MGE, short CBOT spreads because it's not clear why a general shortage of wheat would cause buyers to prefer low-protein to high-protein. Sure speculators may flock to the CBOT contract initially, but the real commercial value of the CBOT product would not be positively affected.

Just to reassure myself, I went back to look at the big rally from a couple of years ago that sent MGE over $20/bushel--surely that would cheer me up. Nope. Not only did the wheat price rally initially send CBOT to a premium to MGE, it sent the CBOT to the biggest premium over MGE seen in many, many years--and this just before MGE skyrocketed. So if you had the "right" view on MGE going up vs CBOT, first you had to withstand a drop to record lows. Obviously, not many participants could...it's a very humbling picture.

All Russian Drought ,All the Time

Wheat went higher again; Sep CBOT now up 35% from June 29. CBOT gained a couple of cents against KC and MGE. The calendar spreads flattened a bit. Same market dynamics that have prevailed over the last 20 trading days.

Wheat Still Well-Supported

Wheat finished within a few cents of its recent highest closing price. No 5-10% sell-offs in this grain. So it is relatively easy for CBOT wheat futures to stay well bid vs KC and MGE--speculators continue to buy the CBOT product.

Alternatively, the VSR may be having a more profound effect than I anticipated. While I expected the large storage charges to discourage buyers from holding CBOT wheat, the large incentive to store physical soft wheat may have created a relative scarcity of Soft Winter Wheat. For the past few days, the DTN index of Soft Winter Wheat has been about even with their index for Hard Spring Wheat. Apparently, if a grower has on-farm storage, he is just holding back the soft wheat to pick up the carry. Hmmm.

Looking Back...

One of the reasons to keep a trading journal is to review the beliefs that led to poor trading decisions. While I never went short wheat vs corn, I was comfortable with bear spreads (in wheat) even though wheat was clearly a good value vs corn. I noted in late May that there was little more downside in wheat vs corn, yet added to a position that was vulnerable to a CBOT short-covering rally.

In retrospect, I should have been much more patient, waiting for wheat to trade toward less extreme levels of valuation vs other grains. I bring this up today because wheat has elevated to over 1.6X corn. While this may not be an extreme valuation, it's hard to support with wheat stocks vs usage so high. The trend-followers are now long wheat (and corn). This is a much better environment for bear-spreading.

More Returning to Normalcy

MGE Wheat futures were about 4 cents stronger than the CBOT today, gaining while the CBOT finished in the red. Surprisingly, the Sep MGE contract, which has been weaker than KC or CBOT, has the tightest spread vs Dec of the three contracts. Sep/Dec MGE was only about 16 cents premium Dec, while Sep/Dec KC was 17.50 and Sep/Dec CBOT was 31 cents. Storage at the MGE is about 5 cents/month, so there is little left for interest on capital after delivery fees (vary by broker). Again, this is surprising given that Sep is when the Spring Wheat harvest should be arriving...if ever the MGE should be at a full carry, including a generous rate for interest on capital, it is this September.

By the way, I think that $85K, traded this week, is a great bargain for MGEX seats. I think they're worth double that when you add up the pieces--real estate, cash, trading revenues...unclear when the "liquidity event" might arrive, but I believe a majority of members would welcome an offer from a listed exchange business such as ICE, which bought the old Winnipeg exchange.

Nothing New Today

Wheat futures made fresh highs. Corn and beans and even oats finished lower, so perhaps the wheat rally is running on fumes here...

Nearby CBOT Spread Inches Closer to VSR Maximum

While the newly sprouted Wheat bulls continue to talk up the decline in supply, there is nobody currently willing to pay a premium to control supply. This is not the cocoa market. You can be bullish and you may be right, but you have to pay top dollar to carry that position now.

Since there is plenty of wheat to go around through the next harvest, the bullish view really assumes not only a badly damaged harvest this year, but also a poor harvest next year. However, higher prices now (and big contangos forward) will stimulate higher plantings. It may be that the growing season next year will be poor, but it looks like the bullish position still requires a few things falling onto place.

Hard Wheat Strengthens, Contango Steepens

Today's price action could generally be described as a "return to normalcy." CBOT Sep/Dec calendar spreads inched closer to the VSR maximum. Hard wheat premiums grew.

I think it would be a mistake to dismiss the recent rally in wheat prices as entirely misguided. The rally was from very low levels. Cash Hard Red Winter Wheat was selling for close to $3/bushel--much less than the cost of production--and not a sustainable price. There's no reason wheat can't be $5.50 or $6/bushel or even higher. The aberrations that are not sustainable are the flatter calendar spreads when inventories are high. Related to that, it's hard to see why protein premiums shouldn't reassert themselves as buyers face a well-supplied market.

Where's the Top?

Unfortunately, there won't be a sign posted. Wheat was pretty strong again today, giving back only 1%-- even as corn dropped 3-4%. The calendar spreads stayed at the much flatter contangos established last week; the Dec/July11 CBOT is almost the same price as the same period on the KCBT and the MGE. Given that storage rates will cost CBOT holders more than double the rates at the other exchanges (and there will be wheat in storage), that's very tight.

The CFTC COT report showed trend-followers now long wheat as well as the other grains. It took quite a large price rise to induce commercial sales that cover both the commodity index longs and the managed-money longs. Now that both those sectors are on the same (long) side of the market, the August roll period (Sep futures to Dec) may go to very steep contango as commercial shorts will only accomodate the rolls at levels that have attractive economics for storage.

While some continue to imply that dry conditions in Europe and Central Asia are bullish for wheat in general, it's hard to see how it should be as bullish for the Winter Wheat crops that are aleady in--as compared to Spring Wheat crops that may see far more impact. If this rally is based on more than short-covering positive feedback loops, then Spring-planted crops like MGE wheat and CBOT oats should outperform eventually.

Prices Can Go Anywhere, They Just Can't Stay There

Eye-popping moves in wheat futures. Sep CBOT up almost 40 cents. Sep/Dec CBOT contango shrinks by a penny. But the Dec/July contango collapses by almost 15 cents? Wow. You got me. Like many others (apparently), I had too much on and had to take some large losses.
My idea is that there isn't all of a sudden a shortage of CBOT wheat. July CBOT was trading at full carry to Sep; Sep CBOT is still going to a full carry against Dec. But we have to pick our spots, and the Dec/ July spread is not where I'm going to make a stand.
So I've pruned our position back to just long MGE vs CBOT and rolled it to Dec-that spread closed with Dec MGE just 4 cents over CBOT.

The 30% rally in wheat prices over the last three weeks will certainly kill some demand. Whether there is actually significant crop damage in Eastern Europe/Central Asia remains to seen; the USDA had already factored in some damage in their most recent report predicting a large carryout. There is virtually no chance that the damage is significant enough to cause tight supplies before the next new crop. Nor any reason to think that European crop damage would make CBOT wheat equivalent in value to MGE wheat. Time will tell.

You Just Have to Have Wheat

Yesterday's "strange" price action on the close was just plain wrong today. As the wheat market rallied another 2%, the CBOT calendar spreads went back to flattening out. Again the CBOT outperformed the other futures markets on the way up--indicative of speculative interest.

It's hard to say how far this rally will go. The strengthening Euro helps wheat go higher. Generally higher commodities spur a bit of commodity index buying. Could be some smaller harvests in Central Europe.

I don't think there's much left. I think the Dec/July11 spread is being forced to smaller July11 premiums because there are producers locking in high forward prices while speculators are buying the nearby months. There isn't a shortage and it won't work out well for the speculators. While it is certainly possible that they make money from here on wheat longs, it's hard to believe that speculators wouldn't do better to buy corn, beans, ethanol... something that isn't at full carry.

Strange Closing Action

Okay, there were buyers of wheat on the close, no surprise there. But as the Sep contract traded up to the highs, interest came into the calendar spreads to sell the front/buy the back, pushing Dec/July to a 4 cent steeper contango in just a few minutes.

Generally, this is what I expect on the calendar spreads-- though not while the market is sprinting higher. Since Sep MGE/CBOT didn't move much on the day, the effect of the calendar move was to drive up July11 CBOT to within 2 cents of MGE. A month ago, we saw July10 MGE at 75 cents over CBOT. So far it looks like there will be larger inventories of Spring Wheat next July, and somewhat smaller Soft Winter Wheat inventories, but I don't believe it adds up to an equivalence in price; there will be plenty of both and hard wheat will still have a premium.

Respite or Turnaround?

After a weak opening, MGE wheat futures gained quickly against the CBOT, finishing a nickel stronger on the spread. Neither market moved much in outright terms; MGE a couple of pennies up, CBOT a couple of pennies down. Certainly the CBOT did not appear under a whole lot of pressure--the calendar spreads remained at last week's levels. The MGE did look stronger with the calendar spreads there flattening a bit.

The CFTC COT report did show considerable short covering and assuming further covering after the Tuesday cutoff, the trend-followers look to be about flat at this point. Does that mean that the relative wheat futures values are now at "fair" levels? Not exactly. Perhaps it does mean that we are at more normal levels of distortion due to commodity index positions. But those levels, July11 MGE 5 cents over CBOT, July11 KC at a discount to CBOT, are still distorted-and therefore attractive.

USDA Report Sends Wheat Down a Bit

The USDA reported on the World Ag Supply/Demand today. Highlights included a 2.5% lower projection for global wheat inventories due large to lower output from Former Soviet Union producers that was as expected and a very high yield estimate for the USA's current domestic production which was also expected. The wheat futures generally opened and closed down a dime--off 2% after a 20% rally in 8 sessions.

Our spreads didn't move much. CBOT calendar spreads were at a slightly steeper contango after the report; intermarket spreads fluctuated around yesterday's levels.

We weren't really expecting a miracle today in terms of great news to drive our positions, and we didn't get one. The past couple of weeks have been a useful case study in how markets make opinions: news blurbs now are pointing to hot weather spots and wet patches and rain-delayed harvestings, gone are the discussions of the surplus inventories in India so large that all proper storage is full and wheat is being stored out in the open air in piles.

Clearly, wheat inventories remain very large and the current production is relatively high. It's certainly possible that trend-followers will embrace wheat after these strong moves higher--driving the nearby CBOT to higher levels vs other alternatives. We will have to wait and see. But given the volume of wheat in storage, physical buyers can afford to be choosy; hard to see why they would choose low-protein, soft wheat at levels close to hard wheat. Also hard to see how speculators benefit from holding a commodity where storage is running at over 20% annualized and may get even more dear.

Should've Gotten a Job with a Pension...

Sep CBOT wheat was popular again today. The crop is well on its way to a good harvest on top of a big inventory. Spring wheat (MGE) there's some uncertainty left on weather; Corn demand is very strong; Oats have weather issues and a smaller crop planted....but Winter wheat, all you're looking at (if you're outright long) is high storage fees for a long time.

Well, I guess this is the beauty of the wheat market today--opportunities galore. While managed-money shorts have to cover on rallies, the commodity index longs will ignore wheat market fundamentals, charges and other technicalities and keep holding Sep CBOT until the beginning of August.

Sep CBOT outperformed MGE by about a nickel, crunching the spread into about 25 cents by the close--July11 MGE traded at less than a nickel over CBOT. While it is certainly possible that July11 MGE could trade at 15-25 cents under CBOT, it's very, very unlikely to finish there. Unless crackers start trading at a premium to bagels...

Why I'm Long Sep MGE vs CBOT

Wheat rallied another 4% today helped by continued gains in corn and a generally positive backdrop for commodities. Over the past few weeks, the wheat:corn price ratio has gone from 1.25 up toward 1.40. Since the only really bullish news has been in the corn market, it shows the impact of the non-commercial traders in grains--corn speculators have been long, while wheat specs have been short until now.

While a rally like this would typically hurt our short, front-end CBOT positions vs MGE wheat and back-month CBOT longs, that was not the case today. The CBOT contango steepened and hard wheat futures outperformed the CBOT. Today we saw the July11 MGE/ CBOT spread at about 5 cents premium for MGE. While it is certainly possible for MGE to trade at a discount to CBOT, at present there does not seem to be any fundamental economic case for that scenario. Eventually, the pressure of the more expensive carry on the CBOT, along with the lower protein content, will have its effect.

Even as the wheat market was up over 20 cents/bushel today, the Sep/Dec CBOT spread went to 29 cents while MGE remains inside of 17 cents. It is unclear to me why the CBOT Dec/July11 spread is still around 50 cents; the same monthly rate as Sep/Dec would put Dec/July11 at 67 to 68 cents. And while there should be less physical wheat to store from Dec to July11, there will be wheat to store and the VSR rate at the CBOT will likely be higher than the rate from Sep to Dec.

If Sep/July11 CBOT spreads move toward $1 bushel and July11 MGE vs CBOT trades at a more reasonable 25 cent premium for MGE, that works out to something more like 75 cents premium for Sep MGE over CBOT (30-31 cents today)--so that's where I see these spreads going.

Trials and Tribulations

By the close, most aspects of the wheat futures were close to unchanged. The front-end contangos steepened: Sep/Dec about 2 cents more premium Dec. The back-end was flatter: Dec/July11 3 cents less premium July11. Intermarket spreads ended near unchanged after an initial move toward continued CBOT strength--the CBOT started the day up 20 cents/bushel, but fell back to a close up less than a nickel.

Overall, the calendar and intermarket spreads have moved back to levels I thought we would never see again on these contracts. At the beginning of March, one of the first calendar trades we did was short Dec10/ long Dec11 at around 80 cents premium Dec11. That premium moved up steadily to well over $1, but has dropped all the way back to 80 cents again. While the intermarket spreads aren't all the way back, Sep MGE/CBOT was available at 25 cents premium MGE today--much closer to the roughly 15 cent premium for the front month we saw in early March than the 75-80 cent premium prevailing in early June.

Not much has changed in the fundamentals of these trades. Demand has been OK. European prices have moved up, taking some pressure off export competition. But inventories of all US varieties of wheat continue to be quite large by historical standards, with no prospect of any shortage through the next US harvest. The VSR regime at the CBOT appears to have solved their cash/convergence problem. It looks like the steep CBOT contango encouraged traders and producers to store CBOT Soft Winter Wheat instead of selling it outright. It's possible his has made KC Hard Winter Wheat relatively less attractive to store and correspondingly more attractive to sell for cash--driving the cash to a large $1.30/bushel discount to KC futures. While the cash/convergence problem may have moved, there is still plenty of cheap cash market wheat available.

Essentially, most of our wheat market variables have been reset to similar values to 4 months ago (unfortunately, including P&L)--I think this represents an opportunity just as good this time around.

**Maybe my posting problems relate to Google Blogger issues--I notice that posts that definitely have 2 comments below, still read "1 comment" below the post. Thanks for the comments BMH.

Another Post Lost in Cyberspace...

I have had a few very bad trading results over the past two weeks, but I haven't stopped the daily posts. Something about posting using the hotel wi-fi just didn't work consistently.

As of last Friday, I thought the worst of the damage had been done--that most of the short-covering on the CBOT that squashed the MGE/CBOT premium and the CBOT contango had taken place. This morning that is not so clear. The CFTC COT report didn't show a lot of short-covering through last Tuesday and the spike up in wheat prices indicate there were still more stop-losses to be hit.

Of course, I am mainly on the lookout for signs that our current positions are wrong, as opposed to poorly timed. The July/Sep wheat futures spreads are still at full storage costs (though not much beyond that). The Sep/Dec spreads do not reflect any tightening of supplies on any exchange. The only real mover this morning is Dec/July CBOT, where I believe outright sellers of the 2011 crop are combining with front-end short-covering to force in the spread.

While the market can stay irrational longer than we can stay solvent, as Dec/July trades into levels inside of actual storage costs (around 52 cents), we can expect producers to unwind hedges and sell the cash Soft Winter Wheat or roll the hedge at least back from July11 to Dec10.

What a Disast.....uhhh, Opportunity (part 2)

I did write a post yesterday....don't know why it didn't go up.

The gist of it was that we've seen a lot of trend-follower short-covering. There isn't any particularly bullish wheat news nor any CBOT soft wheat shortage.

Our timing so far has been disastrous on the intermarket spreads, but I think we will see a recovery in hard wheat futures premiums.

Nothing Special Today

Wheat futures were down just like everything else that isn't yellow and shiny. There was some movement in calendar spreads to steeper contango. The intermarket wheat futures didn't show much direction, but that's a little surprising; a strong down day, particularly a day when the price drops are due to stronger USD and weak equity/risk markets as opposed to weather factors, would likely draw more selling into the CBOT than KC or MGE. So the fact that KC and MGE didn't strengthen their premiums to the CBOT is a bit disappointing.

To Answer Friday's Question...

There was short-covering in wheat by trend-followers in the recent CFTC COT report, but that report was only through Tuesday and the market didn't really turn down until later in the week....

Anyway, new week but MGE Spring Wheat futures still the weakest. After a couple of days on the sidelines, we are tip-toeing back in. Trying to get back to the fundamentally appealing trades, we mostly bought July11 MGE at 16-17 cents over CBOT (July10 topped out at about 80 cents over). As usual, I am wary of being short CBOT futures a year forward as the contango could steepen and drive the forward prices up, but we also added to our CBOT calendar spreads (sold Sep10/ bought July11)to offset this concern.

Ethanol managed to get a bit cheaper; it dropped more than corn and more than gasoline. It's hard to understand that kind of weakness when producer margins are low and the nearby ethanol market is in backwardation. Although it's not really my specialty, for my personal, non-wheat, non-spreading account, I am outright long a few ethanol contracts.

Specs Covering Shorts in a Down Market?

Why are the CBOT wheat futures falling less than MGE or KC? Could be short-covering from the trend-followers that are short. I dunno.

To put our recent losses in perspective, we lost about 8 cents on the intermarket Sep MGE/KC spread in a market where MGE dropped around 25 cents from the highs vs. the CBOT--our usual benchmark. We are 3-4 cents underwater on our CBOT calendar spreads (Sep/July11 and Dec/July11) on a move where the July10/July11 narrowed by almost 20 cents. So I was wrong on these spreads, but it could have been worse.

At the very front of the market, the July/Sep CBOT spread steepened back to 15 cents premium Sep--so the carry offers a tiny bit of yield in addition to storage costs of 14.5 cents. As we look out the curve, the Sep/Dec spread looks too narrow. As noted, the front July/Sep is at the VSR maximum storage rate; beyond the Sep/Dec, the Dec/March is trading 1-2 cents wider contango than Sep/Dec; since there won't be much new wheat in the fall, the supplies can only be lower in Dec; the implication is that Dec/March is steeper because the VSR maximum is potentially steeper for that period. If there is a belief that Dec/Mar should be steeper than Sep/Dec, then Sep/Dec would have to go to the VSR maximum of about 34 cents (27 today).

Lastly, ethanol is getting very cheap again. Controlling for energy content, nearby ethanol is less than 10 cents/gallon premium to gasoline. I don't believe that premium has gone negative for some time. Considering that by volume ethanol is around 60 cents/gallon cheaper than gasoline and there's a 45 cents/gallon credit to blend it, ethanol consumption should be at the maximum--not to mention exports setting new records. With the BP disaster ongoing, it is hard to see how a higher blend wall, at least to E-12, can be put off much longer.

More Struggles ...

The worst enemy of our strategy is low inventories. Short-covering rallies on the CBOT cause pain, as I think we saw today, but not permanent damage.

We junked the long MGE/short KC position.

I will look to re-establish a long MGE/short CBOT intermarket futures position sometime. I believe that the trend-following shorts have to exit the CBOT for the MGE/CBOT spread to be attractive to us once again. As long as the CBOT leads the rally, the calendar spreads we have (short the front/long the back) may cause some further pain..we don't need additional exposure to directional wheat trades right now.

About as Happy as the French Soccer Team

Of the two main positions outlined in yesterday's post, the MGE vs KC is the one that does not really fit with our core mission of exploiting index traders and the VSR regime. The MGE vs KC position is much more predicated on knowing something about the wheat markets--maybe that's why it's not working. We held it today, but we will not keep it much longer unless the P&L starts to get real positive, real fast.

At the CBOT open, the nearby July/Sep spread narrowed to inside of anticipated exchange storage costs (14.5 cents)--from 15 cents premium Sep to only 12.5 premium. The market then drifted back to around 13.5 cents for the rest of the day. First Notice is about a week away and this is a surprising move that needs to be watched. Neither the MGE nor KC spreads exhibited any similar moves.

No New News

We have a couple of main positions: long Sep MGE/ short KC and short Dec10 CBOT/ long July11 CBOT. Both spreads stayed within a penny of yesterday's prices for most of the day.
On the MGE vs KC position, we are not in at some great level where we can relax and count on time being on our side. We are long at the highest level for that spread in months. The revelation that Canadian farmers didn't plant a big chunk of planned acreage has pushed MGE up by about 10-15 cents vs KC and CBOT and that premium has held up at these new levels for a good week now. The oats market is more sensitive to Canadian production problems than MGE Spring Wheat so I'm hoping the 5% rise on oats today, to new highs, is a harbinger of further MGE gains vs KC and other lower protein, winter wheat.
On the calendar spreads, we can be somewhat more comfortable, though there is no hard number supporting forward premiums. The winter wheat harvest is almost 20% complete with generally favorable weather conditions forecast for the weeks ahead. There is a large inventory of winter wheat and a good crop almost in the bin. While spreads have scraped themselves up off full carry at the KC (by a few pennies), there shouldn't be much concern over any shortage of winter wheat for a year at least.

Grains Flop First

Grains opened higher, presumably in sympathy with higher commodities and equities on the back of the Chinese Yuan news, and immediately headed back lower. The action in intermarket spreads and calendar spreads was mixed. We were able to add to our CBOT short Dec10/ long July11 spreads at close to the lowest premium levels for July11 seen for weeks.

At the front end of the market, July/Sep MGE spreads were trading very close to exchange storage costs and the rest of the MGE forward curve is at lower premiums than storage, so that would be the "tightest" market. As far as the CBOT vs KC forwards, it is like the tale of the Walrus and the Carpenter; the CBOT forward premiums are bigger, but the KC forwards are the most premium beyond exchange storage costs.

In general, exchange storage costs are below third-party, open-market storage fees. The last survey I saw pegged average "real" storage costs at about 7.5 cents/bushel/month, while the KC charges 4.5 cents, MGE charges 5 cents, and the CBOT will go to 8 cents starting July 19 and likely up to 11 cents in September. The VSR rules allow storage rates to rise 3 cents/month every expiration where the nearby spread is trading over 80% of the then current "full carry" (storage plus interest). It is possible, therefore, that storage fees will rise to 14 cents/month in December and more in March, and then May.... Eventually, it will be economic to move the grain out of CBOT elevators or something else will give, but there is still room for steeper CBOT contangos. While Sep/Dec should top out around 34 cents (currently 30), Dec10/July11 isn't capped until around 115-120 cents (currently 62). I expect the real storage and transport economics to keep the Dec10/July11 inside of that VSR maximum, but there could still be quite a bit of room to move.

Scaling Back Positions

As the KC market strengthens vs the other wheat futures, I find myself thinking that the market is wrong-- and there will be consequences! That's usually a sign that liquidation is prudent. So we took off about half our intermarket futures exposure.

As the CBOT spreads widened to huge contangos over the past few months, that particular bet seemed less and less attractive. I think a sustained rally in prices would flatten out the calendar spreads and perhaps give us an opportunity to re-enter both calendar spreads and intermarket spreads at much better levels.

The market dynamics this week--hard wheat futures rallying faster than CBOT--are not typical of the past few months. I believe the previous pattern of higher CBOT volatility will eventually reassert itself. Until then I'm going to be more cautious.

A Theme that Isn't Working

We almost have it right. The market is rallying and hard wheat futures are outperforming the soft wheat futures. But for reasons unknown, KC is outperforming the harder Spring Wheat futures on the MGE. It appears that the elevators that are certified for KC delivery are enjoying huge margins. This may be the same dynamic that led to very wide cash/futures margins at the CBOT over the past few years and also very high levels for CBOT futures versus other wheat futures.

Last week's CFTC COT report showed some selling by commodity index funds. So far this week, I've been surprised that the CBOT, with its big non-commercial short interest, hasn't rallied faster. I've been afraid to short the CBOT on a spread against MGE because I expect there will be stop-losses triggered that drive up the CBOT price. I will be looking at tomorrow's CFTC report to see if the shorts are standing pat or if commercial sellers or index sellers are offsetting the short-covering.

We added a bit to our long MGE exposure today- some against KC, some against CBOT.

A Humbling Trading Day...

The wheat nobody wants is not always the same as the wheat futures nobody wants. Hard Red Winter Wheat may be trading, on average, at $1.20 below the July KC futures, but July KC was the best performer on the day. KC outperformed CBOT by 3 cents and MGE by around 5 cents. Exactly what we didn't want to see.
We scrapped the long CBOT/short KC position. We kept the long MGE/ short KC position. The former was supposed to benefit from a rally in outright wheat prices...it didn't, and it's not a "core" position that we are going to build a strategy around, so we are flat there now. In contrast, the MGE should continue to benefit from a widening protein premium. The weather news from Canada may well have more impact than the 10-15 cents that the market has added to the MGE premium to KC.

We took off the short Sep/long Dec CBOT calendar spreads we just recently put on. As the outright market rallies, there may be better opportunities to short the front/ buy the back.

Outside of the explosive rally in oats, the conventional wisdom in grains is that the large inventories of wheat will act to suppress any significant rally. While this may be true, it is also baked into the price. I think it's likely we will see higher consumption (especially livestock feeding) and we know there will be lower production from the Far North. A 100 million bushels here, 200 million bushels there and there isn't such a large inventory anymore.

Oats: The Big Bull Market....Who Would've Guessed?

July Oats tacked on another 10% today to make it about a 40% rally in a week. Tough to square with a strong Efficient Markets Hypothesis, since most of the rain was spread over a 6 week period, but there it is. We exited our tiny foray early last night; the idea was to take a small position and hold it, but the market quickly moved to levels where I felt there was too much risk.

The same weather affecting oats is impacting Hard Spring Wheat as well; July MGE stayed up around 70 cents over CBOT. We put on a new long July MGE/ short KC position (43 cents premium MGE), while adding to our long July CBOT/ short KC position (26+ cents premium KC). The Minneapolis long is a bet on further movement from the Canadian wet weather--the protein premium for Hard Spring Wheat should increase. The CBOT long is a bet on short-covering from trend-followers eventually pushing up CBOT relative to the other markets. Clearly, we could be hurt by strength in KC, but that should be weighed down by weakness in cash Hard Winter Wheat and doesn't have a large non-commercial short interest.

Lastly, we have a small long Dec Ethanol/short Corn position. Ethanol inventories remain rather tight with the market in backwardation through October and carries less than storage through January. ADM has apparently lobbied hard for an increase in the 10% blend wall--even if only to 12% instead of 15%. Currently the ethanol "crush" vs corn is only a bit over 25 cents/gallon in Dec--around the year's lows.
[Crush=Ethanol-(Corn/2.8) A more accurate version includes the benefit from DDGs sold for livestock feed, but gives similar results.]

All Wet in Canada

The MGE wheat contract, for Hard Spring Wheat, got a big boost today from news out of Canada. About 20% of Saskatchewan and Manitoba never got planted--not with wheat, not with barley, not with oats. Too much rain has left fields flooded. I don't know how this info was not available to the USDA for their most recent world crop estimates, but it came as a big surprise to the futures markets.

The July MGE jumped over a dime, to 70 cents over CBOT. The MGE July10/July11 spread flattened by a nickel to 60 cents premium July11. We did not anticipate this move and did not have anything on intermarket or in MGE calendar spreads. While this news is bullish for wheat, and especially Hard Spring Wheat, there is hardly a shortage--All the July/Sep spreads continue to trade at more than 100% of storage. I anticipate that the wheat market will stay in a full carry through the harvest in 2011. We were able to sell Sep/ buy Dec CBOT wheat at 25 cents; last week that was over 30 cents and the maximum VSR full carry would be around 34 cents.

We did jump in to buy oats vs corn (as I mentioned last Friday). After we bought our small oats position, the market went limit up-for now I am holding off putting on the hedge.

Some Follow-Through on the USDA Report

The main surprise in the USDA report yesterday was the higher corn consumption/lower ending inventory; today's grain markets seemed to reflect some knock-on effects. While the highlight in corn was the greater usage for ethanol, I think we will see more surprises on consumption. With cattle prices relatively high, there is a lot of incentive to feed cattle longer. In fact, some the hard winter wheat that is trading at over $1 under July futures will also likely end up as animal feed. I got an estimate of 100MM bushels or 5-10% of the hard winter wheat crop potentially being diverted. Similarly, US exports of ethanol (from cheap corn) will set records, easily displacing Brazilian sugar-based product, unless the US raises the blend wall from 10% to at least 12%--either way, more consumption.

So I'm still looking for more bouncing from current levels. If trend-follower short-covering starts to kick in, the buying should mostly be headed to the CBOT. We maintained some of our long CBOT/short KC position and we may add to it, especially on an intra-day basis, if the CBOT rally continues.

In a very interesting development, The CBOT calendar spreads flattened a bit. From a peak of 49+ cents over July, Dec traded down to less than 44 cents over.
But in KC, the spreads stayed pinned to full carry. This is indicates that the extemely weak cash/futures basis is related to whether the futures are at full carry. The carry is larger at the CBOT (July to Dec costs less than 30 cents at KC), but the CBOT is trading at less than 100% of the likely storage fees, while the KC spread is trading at over 130% of storage fees. This set-up seems to lead to a failure of the full carry market to converge at delivery.

Finally, I'm taking a good look at the oat futures--they are pretty cheap vs corn, it's a small crop, and they may have some weather issues in the Canadian growing areas. Really, we should have had it on already, but I would be looking for a relatively large move, 10-15%, on a small position, so the timing doesn't have to be perfect.