OK, I'm surprised. Despite the relentless drop in grain prices, inventories are growing and planting intentions are higher. The market offered some opportunities for trading today, but I was too nervous to jump in. Pretty foolish in hindsight. It was a pretty simple story: bigger inventories ahead -- and wheat opened lower and traded down all day.
As has been the norm, CBOT led the market down and the premiums for KC and MGE returned to their highest levels of the month (many months, really). Had we not flattened positions last week, we would have been disappointed, though. With the market down another 20 cents/bushel, premiums only returned to 11+ cents for KC and about 32 cents for MGE. In this environment, I'm just looking to enter on the long KC or MGE/ short CBOT side, and we can afford to be picky.
The move down in grains is not helpful for the ethanol/gasoline position. In fact, the short gasoline side is very worrying. There are the usual worries about bullish oil news, but also the concern that S&P will continue upward and onward. We may have this trade on at the wrong scale; I would prefer having a position only half the size, but that would be too small to be practicable.
Wednesday, March 31, 2010
Tuesday, March 30, 2010
Waiting for the USDA
Wheat futures traders, including this one, spent the day assessing risks going into tomorrow's crop report. We will get numbers both on usage to date and planting intentions. I will be surprised if the market gets the higher spring wheat planting numbers it's looking for. Generally, the non-commercial spec traders were looking to cover for most of the day, and the market rallied about 1.5% on the close as they took some chips off the table.
The late rally squeezed the MGE and KC premiums for May down by 3-5 cents, so, for now, we're glad we squared up last week on intermarket wheat spreads. On the calendar spreads, where we have positioned for steeper CBOT contangos Dec10/Dec11, we hedged with the reverse on KC Dec10/Dec11. We were a little lucky, since this is how I wanted to position and interest came into KC just when we wanted. In a nutshell, we have locked in holding Dec10/Dec11 KC wheat at 2.5% over storage costs while selling Dec10/buying Dec11 CBOT at 4% over current storage fees--but the CBOT storage fees are variable, and will rise by 7.2% (annualized) come July, while KCBT storage rates will not be changing. So while KC is trading at a "full carry," CBOT is not even close to full carry.
As I write this, the long ethanol/short gasoline trade is not doing much. Crude and gasoline are tracking S&P's a little higher; the rally there continues, but is, hopefully, running on fumes.
The late rally squeezed the MGE and KC premiums for May down by 3-5 cents, so, for now, we're glad we squared up last week on intermarket wheat spreads. On the calendar spreads, where we have positioned for steeper CBOT contangos Dec10/Dec11, we hedged with the reverse on KC Dec10/Dec11. We were a little lucky, since this is how I wanted to position and interest came into KC just when we wanted. In a nutshell, we have locked in holding Dec10/Dec11 KC wheat at 2.5% over storage costs while selling Dec10/buying Dec11 CBOT at 4% over current storage fees--but the CBOT storage fees are variable, and will rise by 7.2% (annualized) come July, while KCBT storage rates will not be changing. So while KC is trading at a "full carry," CBOT is not even close to full carry.
As I write this, the long ethanol/short gasoline trade is not doing much. Crude and gasoline are tracking S&P's a little higher; the rally there continues, but is, hopefully, running on fumes.
Monday, March 29, 2010
Grains are cheap, crude oil is expensive--how to position?
My attention drifted from the various wheat futures today while I pursued a trade based on the "relative value" posts below. There are many links in the relative value chain from wheat to corn to ethanol to gasoline to crude oil. All the links involve variations which can persist for many months at a time. Some of the links involve other commodities; sugar prices (as a competing source) can impact ethanol as can natural gas (as an input cost).
My analysis led me to a trade buying ethanol vs selling gasoline. Any "pull" on the grain markets from energy markets could be reflected in higher ethanol production margins as that demand is transmitted via ethanol, so I didn't want to own the grains themselves. Likewise, I wanted to short the gasoline for which ethanol would substitute and not take on further gasoline refining margin risk by shorting the underlying crude.
At just over 70% of gasoline in $/gallon, ethanol is just about economic even without the 45 cent/gallon blenders' tax credit--but there is a tax credit, so it is very attractive to blend with gasoline here. And by June the Obama administration will release their report on raising ethanol blending to 15% from 10%. This trade could go wrong by 5%, but not by 10% unless there is a panicky spike in gasoline. Gasoline inventories are slightly above 5 year averages and vehicle miles dropped year over year in the most recent report, so the panic would have to come from outside the domestic gasoline market.
On the upside, we could see a 10-15% rise in ethanol prices with corn prices constant as ethanol moves toward economic parity with gasoline (inclusive of the tax credit). There is enough room in variation in ethanol refining margins to allow that kind of move from current levels. Or we could see corn move up on weather. Or we could see gasoline fall as the economic outlook (or the S&P500's approximation of the economic outlook) turns down.
If this trade goes wrong, we will exit pretty quickly; if it goes right, we will try to hang on for a significant move.
My analysis led me to a trade buying ethanol vs selling gasoline. Any "pull" on the grain markets from energy markets could be reflected in higher ethanol production margins as that demand is transmitted via ethanol, so I didn't want to own the grains themselves. Likewise, I wanted to short the gasoline for which ethanol would substitute and not take on further gasoline refining margin risk by shorting the underlying crude.
At just over 70% of gasoline in $/gallon, ethanol is just about economic even without the 45 cent/gallon blenders' tax credit--but there is a tax credit, so it is very attractive to blend with gasoline here. And by June the Obama administration will release their report on raising ethanol blending to 15% from 10%. This trade could go wrong by 5%, but not by 10% unless there is a panicky spike in gasoline. Gasoline inventories are slightly above 5 year averages and vehicle miles dropped year over year in the most recent report, so the panic would have to come from outside the domestic gasoline market.
On the upside, we could see a 10-15% rise in ethanol prices with corn prices constant as ethanol moves toward economic parity with gasoline (inclusive of the tax credit). There is enough room in variation in ethanol refining margins to allow that kind of move from current levels. Or we could see corn move up on weather. Or we could see gasoline fall as the economic outlook (or the S&P500's approximation of the economic outlook) turns down.
If this trade goes wrong, we will exit pretty quickly; if it goes right, we will try to hang on for a significant move.
Friday, March 26, 2010
Taking a Breather
Wheat gave no signs of turning higher today--even with a weaker dollar, wheat probed new lows. Still, I made myself nervous enough with the Relative Value post below that I squared up intermarket positions in MGE and KC vs CBOT wheat. I also took off most of the calendar spreads, though the Dec10/Dec11 spread still has interest coming in to sell Dec10/ buy Dec11 at a bit over 80 cents.
Perhaps we will see hard wheat (MGE and KC) premiums expand over the next week; the trend is certainly that direction and there's no fundamental reason that the premiums can't be much higher. On the other hand, there's more downside in those spreads today than a few weeks ago, and there are likely more CBOT non-commercial shorts. So we're flat and we will take a fresh look next week.
Perhaps we will see hard wheat (MGE and KC) premiums expand over the next week; the trend is certainly that direction and there's no fundamental reason that the premiums can't be much higher. On the other hand, there's more downside in those spreads today than a few weeks ago, and there are likely more CBOT non-commercial shorts. So we're flat and we will take a fresh look next week.
Relative Value Investigation: Day 1
How cheap is wheat? As I looked at the physical market in a couple of locations, it seems that wheat is still 5-15% above the price levels where US livestock producers will have to take a serious look at substituting wheat for corn. Certainly growers are motivated to maximize plantings of other grains than wheat at these levels. The only news reports on substitution concerned a few non-US markets, like the Philippines, with local corn production problems that were importing European wheat for animal feed.
But one news item really caught my eye: it was in the World's Best Rail Journal, featured on a link on this very website. Motiva, a joint venture of Shell and Saudi Aramco, has an ethanol terminal in Providence, RI, and it is exporting ethanol to Europe. Since ethanol has often been vilified as over-priced and generally useless, I was surprised. CME May ethanol is down to 70% of the New York Harbor gasoline contract. Even without a subsidy, ethanol is economically competitive at these levels; this is very cheap ethanol. Further, even with sugar back down below 18 cents/pound, US ethanol is priced competitively with Brazilian ethanol--thus explaining European imports from the US arranged while sugar was north of 20 cents.
So the gist of my thinking is that wheat doesn't have a lot of downside vs corn, but perhaps some. Ethanol production margins could grow, but higher gasoline will eventually start to drive corn. All in all, both wheat and corn are close to the bottom of their potential values vs gasoline. These relationships are too loose for making large leveraged bets where timing is key. However, we should bear in mind that the wheat market is at current levels only because of very high short positions maintained by trend-followers that are accommodating the commodity index longs.
Over the next few months it's very likely we will see grains improve versus gasoline. Whether it is due to short-covering in grains or a sell-off in oil is hard to say.
But one news item really caught my eye: it was in the World's Best Rail Journal, featured on a link on this very website. Motiva, a joint venture of Shell and Saudi Aramco, has an ethanol terminal in Providence, RI, and it is exporting ethanol to Europe. Since ethanol has often been vilified as over-priced and generally useless, I was surprised. CME May ethanol is down to 70% of the New York Harbor gasoline contract. Even without a subsidy, ethanol is economically competitive at these levels; this is very cheap ethanol. Further, even with sugar back down below 18 cents/pound, US ethanol is priced competitively with Brazilian ethanol--thus explaining European imports from the US arranged while sugar was north of 20 cents.
So the gist of my thinking is that wheat doesn't have a lot of downside vs corn, but perhaps some. Ethanol production margins could grow, but higher gasoline will eventually start to drive corn. All in all, both wheat and corn are close to the bottom of their potential values vs gasoline. These relationships are too loose for making large leveraged bets where timing is key. However, we should bear in mind that the wheat market is at current levels only because of very high short positions maintained by trend-followers that are accommodating the commodity index longs.
Over the next few months it's very likely we will see grains improve versus gasoline. Whether it is due to short-covering in grains or a sell-off in oil is hard to say.
Thursday, March 25, 2010
More Downward Pressure on Wheat
Earlier in the week, we saw French sales of wheat into Latin America, now we are also hearing about sales from the Black Sea into Latin America. Continued USD strength today pushed May wheat to new contract lows. May CBOT dropped a bit more than KC and MGE: May KC/CBOT firmed to 11 and change, while May MGE went to a 32 cent premium. Calendar spreads were little changed.
We have to remember that there is no necessity for protein premiums to widen in a bear market. This market dynamic seems a function of investor appetite for commodity index products. Should the USD weaken, or energy prices spike up, or the Oracle of Omaha hint he likes silver again, we could see renewed commodity investment and a sharp turn in the intermarket wheat futures spreads. We took off most of our intermarket exposure today; we are almost flat in May MGE with a modest position long May KC/ short CBOT.
I haven't been looking at wheat vs other commodities very closely; I assumed that with May futures at over 1.3X corn, there would not be any real substitution effect. At 1.1-1.15X corn, it usually makes sense to feed livestock wheat instead of corn and soybean meal. This doesn't last for long-cows do not get croissants or bagels in a sane world. Anyway, I need to take a closer look at this since cash wheat is trading at a much bigger discount to futures than cash corn, so the ratio may be approaching these very low levels in the physical market.
We have to remember that there is no necessity for protein premiums to widen in a bear market. This market dynamic seems a function of investor appetite for commodity index products. Should the USD weaken, or energy prices spike up, or the Oracle of Omaha hint he likes silver again, we could see renewed commodity investment and a sharp turn in the intermarket wheat futures spreads. We took off most of our intermarket exposure today; we are almost flat in May MGE with a modest position long May KC/ short CBOT.
I haven't been looking at wheat vs other commodities very closely; I assumed that with May futures at over 1.3X corn, there would not be any real substitution effect. At 1.1-1.15X corn, it usually makes sense to feed livestock wheat instead of corn and soybean meal. This doesn't last for long-cows do not get croissants or bagels in a sane world. Anyway, I need to take a closer look at this since cash wheat is trading at a much bigger discount to futures than cash corn, so the ratio may be approaching these very low levels in the physical market.
Wednesday, March 24, 2010
Dang Markets Don't Do What They Should
All the wheat futures closed within a penny of unchanged and very little changed relative to each other. Given that the recent bearish market driver--lack of US export volumes--should have been exacerbated by the sharply stronger USD, this is a little surprising. While the wheat futures displayed no signs of particular strength, trading in the plus column for less than 10 minutes, the lack of follow-through to the downside is worrying for those of us short the CBOT vs MGE and KC.
In the CBOT calendar spreads, interest came back to the distant futures with fresh orders to sell Dec10/ buy Dec11. It's pretty hard to step in front of these orders in a meaningful way since the volume in Dec11 is less than 100 lots these days, but we try to do our part. We added 5 lots to our position and scalped a 2 lot; our 9 lots puts us in at about 10% of today's Dec11 volume.
In the CBOT calendar spreads, interest came back to the distant futures with fresh orders to sell Dec10/ buy Dec11. It's pretty hard to step in front of these orders in a meaningful way since the volume in Dec11 is less than 100 lots these days, but we try to do our part. We added 5 lots to our position and scalped a 2 lot; our 9 lots puts us in at about 10% of today's Dec11 volume.
Tuesday, March 23, 2010
Bearish News Continues Unabated
Reuters reported French wheat sales to Latin America-Brazil, Peru, Mexico, Venezuela. Ouch. With the USD up and the Euro down at 1.35, wheat will have to drop further to price itself into export markets.
With the price of wheat falling on this dynamic, the contangos steepened and we added to our exposure there-positioning for over-supplied US grain elevators. And the CBOT dropped more than KC and MGE and we added to our position there as well.
With "non-commercial" shorts at near record levels, I would usually be quite averse to adding risk as the bearish trend continues. But the 800 lb. gorilla that is passive index longs is not going to take this wheat and not going to use it. So each day this trend continues we are just seeing the CBOT market grind down toward physical, "real" valuations.
With the price of wheat falling on this dynamic, the contangos steepened and we added to our exposure there-positioning for over-supplied US grain elevators. And the CBOT dropped more than KC and MGE and we added to our position there as well.
With "non-commercial" shorts at near record levels, I would usually be quite averse to adding risk as the bearish trend continues. But the 800 lb. gorilla that is passive index longs is not going to take this wheat and not going to use it. So each day this trend continues we are just seeing the CBOT market grind down toward physical, "real" valuations.
Monday, March 22, 2010
Timid Trading
Flipped 4 spreads for about 1/2 cent net, so that's about $100.
The "strategic" positions--long KC and MGE vs CBOT in May--were under pressure for most of the day as the outright wheat price rallied at the open and held good gains until about 5 minutes before the close. Hard to say why the wheat market was strong: maybe unease over growing "non-commercial" shorts on the CFTC Commitment of Traders report, maybe strength in the equity and "risky" asset markets, who knows.
Spring flooding doesn't look like a problem, but there is plenty of moisture to set up a good spring growing season for winter wheat. Should be plenty of wheat around all year.
May MGE stayed around 25 cents over CBOT; May KC still around 7 cents over CBOT. The only unusual thing in our universe was some interest in Dec10/Dec11 CBOT--there was an order showing 20 lots of interest to sell Dec10/ buy Dec11 at 80 cents (premium Dec11)and about 10-15 traded there. We already have a short Dec10/long Dec11 position at about that level. We'll see if the interest continues and/or grows tomorrow.
The "strategic" positions--long KC and MGE vs CBOT in May--were under pressure for most of the day as the outright wheat price rallied at the open and held good gains until about 5 minutes before the close. Hard to say why the wheat market was strong: maybe unease over growing "non-commercial" shorts on the CFTC Commitment of Traders report, maybe strength in the equity and "risky" asset markets, who knows.
Spring flooding doesn't look like a problem, but there is plenty of moisture to set up a good spring growing season for winter wheat. Should be plenty of wheat around all year.
May MGE stayed around 25 cents over CBOT; May KC still around 7 cents over CBOT. The only unusual thing in our universe was some interest in Dec10/Dec11 CBOT--there was an order showing 20 lots of interest to sell Dec10/ buy Dec11 at 80 cents (premium Dec11)and about 10-15 traded there. We already have a short Dec10/long Dec11 position at about that level. We'll see if the interest continues and/or grows tomorrow.
Friday, March 19, 2010
How Big Is the Wheat Market?
Not so big, really. US production is around $10 billion annually and global output is about 10X that. For comparison, dairy production in the US is worth about $30 billion annually. The US consumes $10 billion in oil in about a week.
So when you're talking about the CBOT's Soft Red Winter Wheat contract, which represents only about 20% of US wheat production, you are talking about a $2 billion dollar crop in annual sales. Right now, the question is where to put all the wheat piling up due to lower exports and lower domestic consumption, but it's easy to see how this market can be "influenced" by large traders in tighter conditions.
Today, the wheat market finished within a couple of ticks of the opening levels and within a penny of last Friday's close. As the market consolidated at these levels, near recent lows, I added to long MGEX/ short CBOT May positions. The biggest worry for these positions is a weak USD that drives up general commodity prices and forces CBOT shorts to cover.
So when you're talking about the CBOT's Soft Red Winter Wheat contract, which represents only about 20% of US wheat production, you are talking about a $2 billion dollar crop in annual sales. Right now, the question is where to put all the wheat piling up due to lower exports and lower domestic consumption, but it's easy to see how this market can be "influenced" by large traders in tighter conditions.
Today, the wheat market finished within a couple of ticks of the opening levels and within a penny of last Friday's close. As the market consolidated at these levels, near recent lows, I added to long MGEX/ short CBOT May positions. The biggest worry for these positions is a weak USD that drives up general commodity prices and forces CBOT shorts to cover.
Thursday, March 18, 2010
Intermarket Wheat Spreads for July 2011
Now it could be that this time is different, but Kansas City July wheat futures at 20 cents under Chicago looks very attractive.
Over the past 5 years, the period when commodity indexes have been very big, the July KC/CBOT spread has never been much below -20 cents (KC discount) and has gone off the board at prices between -20 cents and +100 cents with an average of 30-35 cents premium for KC--which is roughly what the protein premium is worth.
With July KC/CBOT 2011 trading at -20 cents now, what should we do? While the obvious move is to buy the cheap forward KC wheat, the catch is that while May 2010/July 2011 calendar spreads in KC are at (or close to) full carry, with the new VSR for CBOT, the CBOT May 2010/July 2011 could still widen significantly--up to 80 cents more in a worst case for storage fees. So with the front months at current levels, only the CBOT July 11 contract has room to move higher--meaning the spread could go significantly more negative between now and the July 11 delivery.
While I think that going long July 2011 KC at a 20 cent discount to CBOT is a good trade, the problem is that there might be some mark-to-market pain due to CBOT forward pricing going through the roof. The better way to execute on this idea is to maintain a long KC/short CBOT position in the nearby months and receive the pick-up on the carry: KC has the cheapest storage, CBOT will have, by far, the most expensive storage. To see the effect of the movement of the calendar spreads, contrast the May 2010 chart July 2011 chart.
Added to the long KC /short CBOT position today, but not much trading as there was a "back office" issue to sort out. Spreads were being split up with the buys going to one account and the sales to another--not on all of the spreads, but some of the TT executed legged spreads which are executed in a "block" account and then allocated by our clearing broker. They say they'll have it fixed today.
Over the past 5 years, the period when commodity indexes have been very big, the July KC/CBOT spread has never been much below -20 cents (KC discount) and has gone off the board at prices between -20 cents and +100 cents with an average of 30-35 cents premium for KC--which is roughly what the protein premium is worth.
With July KC/CBOT 2011 trading at -20 cents now, what should we do? While the obvious move is to buy the cheap forward KC wheat, the catch is that while May 2010/July 2011 calendar spreads in KC are at (or close to) full carry, with the new VSR for CBOT, the CBOT May 2010/July 2011 could still widen significantly--up to 80 cents more in a worst case for storage fees. So with the front months at current levels, only the CBOT July 11 contract has room to move higher--meaning the spread could go significantly more negative between now and the July 11 delivery.
While I think that going long July 2011 KC at a 20 cent discount to CBOT is a good trade, the problem is that there might be some mark-to-market pain due to CBOT forward pricing going through the roof. The better way to execute on this idea is to maintain a long KC/short CBOT position in the nearby months and receive the pick-up on the carry: KC has the cheapest storage, CBOT will have, by far, the most expensive storage. To see the effect of the movement of the calendar spreads, contrast the May 2010 chart July 2011 chart.
Added to the long KC /short CBOT position today, but not much trading as there was a "back office" issue to sort out. Spreads were being split up with the buys going to one account and the sales to another--not on all of the spreads, but some of the TT executed legged spreads which are executed in a "block" account and then allocated by our clearing broker. They say they'll have it fixed today.
Wednesday, March 17, 2010
The View from 30,000 Feet
The USA grows much more wheat than it consumes, so exchange rates impact exports and prices very directly. So while it is fun and interesting to contemplate storage fees and protein content and projected flooding in North Dakota, sometimes wheat traders have to think about boring old foreign exchange as well. There has been a lot of interest in whether the Treasury Dept should declare that the Chinese manipulate the RMB in their April 15 report. I have to wonder what has changed since last year: all the same political players at Treasury and the Fed, the same elected officials, the same lousy economy, the same fiscal and trade imbalances. Why now? And does it make a difference to Minneapolis wheat?
The "why now?" could have a variety of answers all rooted in the principle that things that can't go on forever, don't. It seems largely unpredictable to me at this stage. But it would matter. As I have noted in previous posts, there is no bullish news in the wheat market at present--a market which requires a large structural short position from money managers to accommodate commodity index longs at these price levels. Any significant drop in the USD would be very bullish for US wheat exports. In addition to tightening the physical wheat market, the likely jump in commodity indexes accompanying a lower dollar would attract more investors to those indexes. So we would have a situation where there would be higher demand for physicals, higher demand from "investors," and likely short covering from trend-following money managers. Yikes.
Anyway, a sharply lower dollar could create a scenario markedly different from the over-supplied market we have now. Bear in mind, though, we do have an over-supplied market now. As the market rallied 2% today, with the CBOT leading the way, compressing the MGE and KC premiums, I added to our long May KC/ short CBOT position at about 7 cents premium for KC.
In the calendar spreads, where we have been positioned for steeper contangos on the CBOT, we went the other way on KC Sep10/Dec10. At 17.5 cents, that spread is wider than the cost of storage (KC has the cheapest storage at 4.5 cents/bushel/month) by 4 cents. This allows a bit of return on capital even after paying a penny each way to take delivery and re-tender. Using the CBOT method of calculation (200 bp over LIBOR for financing), the KC Sep/Dec is trading at about 105% of full carry.
The "why now?" could have a variety of answers all rooted in the principle that things that can't go on forever, don't. It seems largely unpredictable to me at this stage. But it would matter. As I have noted in previous posts, there is no bullish news in the wheat market at present--a market which requires a large structural short position from money managers to accommodate commodity index longs at these price levels. Any significant drop in the USD would be very bullish for US wheat exports. In addition to tightening the physical wheat market, the likely jump in commodity indexes accompanying a lower dollar would attract more investors to those indexes. So we would have a situation where there would be higher demand for physicals, higher demand from "investors," and likely short covering from trend-following money managers. Yikes.
Anyway, a sharply lower dollar could create a scenario markedly different from the over-supplied market we have now. Bear in mind, though, we do have an over-supplied market now. As the market rallied 2% today, with the CBOT leading the way, compressing the MGE and KC premiums, I added to our long May KC/ short CBOT position at about 7 cents premium for KC.
In the calendar spreads, where we have been positioned for steeper contangos on the CBOT, we went the other way on KC Sep10/Dec10. At 17.5 cents, that spread is wider than the cost of storage (KC has the cheapest storage at 4.5 cents/bushel/month) by 4 cents. This allows a bit of return on capital even after paying a penny each way to take delivery and re-tender. Using the CBOT method of calculation (200 bp over LIBOR for financing), the KC Sep/Dec is trading at about 105% of full carry.
Tuesday, March 16, 2010
Trying to "Make It Happen"
As wheat futures moved higher into the opening, on the back of a lower dollar and much higher oil and gold, I tried to anticipate strong short-covering on the CBOT: during the first half hour, I sold both MGEX and KC wheat against buying CBOT.
Then... nothing. The first half hour was the range for the day and I was left hoping for new highs on the close on the CBOT to compress the MGEX and KC premiums. On the whole, an unproductive, money-losing day. The whole trading idea for the day was too speculative. Luckily, no serious damage done.
Then... nothing. The first half hour was the range for the day and I was left hoping for new highs on the close on the CBOT to compress the MGEX and KC premiums. On the whole, an unproductive, money-losing day. The whole trading idea for the day was too speculative. Luckily, no serious damage done.
Monday, March 15, 2010
Wheat Weakest of the Grains, KC Weakest of the Wheat
With corn almost unchanged and soybeans a bit up on the day, wheat spent the day a solid 1-1.5% lower. As usual, CBOT led the move and the premium for Minneapolis increased. Unusually, KC was even weaker than CBOT and the premium for May KC dropped to about 9 cents over CBOT. On the assumption that this is just some noise, we established a new long KC/ short CBOT position.
While 9 cents over Chicago is not a great bargain for KC wheat from a historical view, in the context of today's inventories and the coming increase in storage charges for CBOT, it is pretty reasonable. This likely adds to the risk we have on our CBOT calendar spreads--both the intermarket spreads and the calendar spreads should do better in bear markets for wheat.
While 9 cents over Chicago is not a great bargain for KC wheat from a historical view, in the context of today's inventories and the coming increase in storage charges for CBOT, it is pretty reasonable. This likely adds to the risk we have on our CBOT calendar spreads--both the intermarket spreads and the calendar spreads should do better in bear markets for wheat.
Thursday, March 11, 2010
Daytrading Minneapolis Wheat
Along with the other grain markets, wheat spent the day probing new recent lows. The premium for May MGE over CBOT ranged from about 25 1/2 to 27 cents/bushel. We were able to flip 20 contracts for around 1/2 cent (2 ticks) each net. It's small, but almost 1% of MGE May trading, so it's not nothing. Now if we could just scalp 1% of the forex market for 2 ticks....
No posts tomorrow, it's a day off.
No posts tomorrow, it's a day off.
Impact of Indexers' Participation in Wheat Futures
As of the March 2 CFTC Commitment of Traders report, the commodity index net longs (swap dealers) comprised over 40% of the open interest in the CBOT wheat futures contract. This contrasts with commodity index longs of 25% of open interest on the KCBT and less than 5% of the open interest in wheat on the Minneapolis Grain Exchange.
This large chunk of the CBOT open interest cannot be accommodated by commercial sellers (farmers) alone. First of all, it is in addition to the normal demand from end users. Second, commercial sellers have been badly hurt by the lack of convergence of the futures to the spot market for Soft Red Winter Wheat, making increased exposure to the spot/futures basis very risky. So the "investor" interest from the commodity index funds has largely been offset by "speculative" shorts by non-commercial money managers.
It is clear that the CBOT contract will be strongly influenced by factors that affect broad commodity investment flows that pump up the long side and also by various pressures and risk controls that guide the money managers on the short side.
In contrast, the Minneapolis market features a more historically normal balance between commercial participants and speculators.
I think this explains why the CBOT is more responsive to developments outside the wheat markets and why the CBOT is more volatile on a daily basis.
This large chunk of the CBOT open interest cannot be accommodated by commercial sellers (farmers) alone. First of all, it is in addition to the normal demand from end users. Second, commercial sellers have been badly hurt by the lack of convergence of the futures to the spot market for Soft Red Winter Wheat, making increased exposure to the spot/futures basis very risky. So the "investor" interest from the commodity index funds has largely been offset by "speculative" shorts by non-commercial money managers.
It is clear that the CBOT contract will be strongly influenced by factors that affect broad commodity investment flows that pump up the long side and also by various pressures and risk controls that guide the money managers on the short side.
In contrast, the Minneapolis market features a more historically normal balance between commercial participants and speculators.
I think this explains why the CBOT is more responsive to developments outside the wheat markets and why the CBOT is more volatile on a daily basis.
Wednesday, March 10, 2010
Big Wheat Inventories, So What?...Well, Here's What:
The wheat inventory numbers were bad, with more in storage than analysts thought. Not a big shock. With outright May down about 10 cents to $4.80/ bushel, CBOT wheat futures sank a couple of cents vs MGE and KC futures with May MGE at a full 25 cents premium and KC over 10 cents premium. Calendar spreads didn't react much so there was an opportunity to bet on steeper contangos at similar levels to before the numbers.
With MGE and KC at over 90-95% of full carry (storage charges plus 200 bp over LIBOR financing), shorting the front/buying the back would not be appealing; should the VSR kick in for Sep/Dec CBOT, full carry will be about 34 cents vs today's 27 cents. And, though I have yet to see anyone say this, VSR could push full carry for Dec 10/Mar 11 CBOT to over 43 cents from today's 24 1/2 cents.
The way VSR works is that the storage rate gets bumped up 0.001/bushel/day, or 3 cents/month, each time the nearby spreads average over 80% of full carry in the period leading up to delivery. There is no limit to the storage charges and they only come down when the spreads average below 50% of full carry in the period leading to delivery. So starting May 19 and through June 25, the CBOT looks at the average July/Sep spread: if it is over 80% of 12 cents, the storage for July/Sep gets bumped to 8 cents/month from 5 cents currently. Then if from July19 to August 25, Sep/Dec is over 80% of 27 cents, then storage goes to 11 cents/month, and so on...
In recent years actual storage costs for wheat, outside of exchange warehouses, have been a little over 7 cents/month. Given that there are costs to move wheat from one warehouse to another(maybe 8 cents/bushel to load out plus transport of up to 30 cents ), I believe most of the wheat will stay put when the exchange goes to 8 cents/month and even 11 cents/month. With inventories large, commodity indexes still popular (and still rolling), and tricky, new, moving target exchange storage rates, I believe we will see a dramatic effect on the Sep10 through Dec11 spreads.
With MGE and KC at over 90-95% of full carry (storage charges plus 200 bp over LIBOR financing), shorting the front/buying the back would not be appealing; should the VSR kick in for Sep/Dec CBOT, full carry will be about 34 cents vs today's 27 cents. And, though I have yet to see anyone say this, VSR could push full carry for Dec 10/Mar 11 CBOT to over 43 cents from today's 24 1/2 cents.
The way VSR works is that the storage rate gets bumped up 0.001/bushel/day, or 3 cents/month, each time the nearby spreads average over 80% of full carry in the period leading up to delivery. There is no limit to the storage charges and they only come down when the spreads average below 50% of full carry in the period leading to delivery. So starting May 19 and through June 25, the CBOT looks at the average July/Sep spread: if it is over 80% of 12 cents, the storage for July/Sep gets bumped to 8 cents/month from 5 cents currently. Then if from July19 to August 25, Sep/Dec is over 80% of 27 cents, then storage goes to 11 cents/month, and so on...
In recent years actual storage costs for wheat, outside of exchange warehouses, have been a little over 7 cents/month. Given that there are costs to move wheat from one warehouse to another(maybe 8 cents/bushel to load out plus transport of up to 30 cents ), I believe most of the wheat will stay put when the exchange goes to 8 cents/month and even 11 cents/month. With inventories large, commodity indexes still popular (and still rolling), and tricky, new, moving target exchange storage rates, I believe we will see a dramatic effect on the Sep10 through Dec11 spreads.
Tuesday, March 9, 2010
Going Flat into the Numbers Release
It's hard to imagine the USDA numbers being meaningfully positive for the wheat market. Last year's crop was big and exports aren't going that well. We already know fewer acres will be planted in wheat. But the world is full of surprises, and even if the numbers aren't surprising, the market reaction might be.
We are still going to look for opportunities to short the CBOT wheat futures vs KC and Minneapolis and to short the front of the CBOT curve against the back. If the market reaction is short-covering by trend-followers, we should get a chance to put on positions at better levels. If not, then at least we have the flexibility to trade any new developments.
May MGEX wheat futures have rallied about 25 cents vs CBOT since the December lows and are within 5 cents of their strongest levels against CBOT for 6 months. While I believe that the major trend for the year will be the weakness of the front end of the CBOT market, I don't think the market will really react until the VSR storage rates start to hurt--which won't be until August or September.
We are still going to look for opportunities to short the CBOT wheat futures vs KC and Minneapolis and to short the front of the CBOT curve against the back. If the market reaction is short-covering by trend-followers, we should get a chance to put on positions at better levels. If not, then at least we have the flexibility to trade any new developments.
May MGEX wheat futures have rallied about 25 cents vs CBOT since the December lows and are within 5 cents of their strongest levels against CBOT for 6 months. While I believe that the major trend for the year will be the weakness of the front end of the CBOT market, I don't think the market will really react until the VSR storage rates start to hurt--which won't be until August or September.
Monday, March 8, 2010
Tight Ranges
All the grain markets appeared to mark time waiting for Wednesday's farm data. Nothing to fear from weather right now...some news reports that India may release inventory onto world markets... There isn't any bullish news anywhere in wheat world.
Over the past few days we have generated slightly negative numbers trying to daytrade the intermarket wheat futures spreads. Given the 1-1.5 penny range on those spreads, it's not surprising we haven't been able to scalp effectively.
More positively, we have had the general drift right on "core" positions--long MGE and KC vs CBOT in the front May contract and in the calendar spreads where we caught a few cents of steeper contango on Sep/Dec CBOT. The levels are less attractive now, so we are scaling out of these positions.
Over the past few days we have generated slightly negative numbers trying to daytrade the intermarket wheat futures spreads. Given the 1-1.5 penny range on those spreads, it's not surprising we haven't been able to scalp effectively.
More positively, we have had the general drift right on "core" positions--long MGE and KC vs CBOT in the front May contract and in the calendar spreads where we caught a few cents of steeper contango on Sep/Dec CBOT. The levels are less attractive now, so we are scaling out of these positions.
Friday, March 5, 2010
Same Wheat Market Dynamics Continue...
While other commodities started out strong on the back of better-than-expected payrolls and stronger prices in Asia, wheat flopped after a higher opening and was quickly in the red. As we have seen all week, the CBOT led the way down stretching its discount to MGE, but the intermarket spread move against KC was quite small. While MGE May futures hit 20 cents over CBOT (up over 8 cents from Tuesday), KC May futures stuck around 6-6.5 cents over CBOT (up 3 or 4 from Tuesday).
The calendar spreads did move to steeper contangos, proving yesterday's trading decision correct. The CBOT spreads could move to bigger contangos still--it does not appear to me that the futures market has fully digested the new VSR regime.
On the intermarket spreads, I am still long MGE and KC vs short CBOT. The hard wheat is very cheap on a historical basis and the new, higher CBOT storage fees and right now, the weak outright market, should force the hard wheat premiums higher.
The calendar spreads did move to steeper contangos, proving yesterday's trading decision correct. The CBOT spreads could move to bigger contangos still--it does not appear to me that the futures market has fully digested the new VSR regime.
On the intermarket spreads, I am still long MGE and KC vs short CBOT. The hard wheat is very cheap on a historical basis and the new, higher CBOT storage fees and right now, the weak outright market, should force the hard wheat premiums higher.
Thursday, March 4, 2010
What happened to all the wheat?
As wheat heads below $5/bushel, it's worth noting that the US, the world's largest exporter, has planted the fewest acres since 1913. And the decline has been pretty rapid. At current prices, farmers continue to switch to corn and soybeans.
Right now the strengthening dollar continues to pressure wheat prices as the US inventories grow with the failure to export at current prices. For the next few days, weeks, or maybe months that will be the main story on the wheat market. Someday the small acreage will combine with bad weather to produce a huge bull market....but not yet.
Right now the strengthening dollar continues to pressure wheat prices as the US inventories grow with the failure to export at current prices. For the next few days, weeks, or maybe months that will be the main story on the wheat market. Someday the small acreage will combine with bad weather to produce a huge bull market....but not yet.
Thursday Play-by-Play
We saw a continuation of the dynamic where the CBOT's greater volatility is a key driver to the intermarket wheat spreads. So when the CBOT headed sharply lower at the open, the premiums for MGE and KC increased. With the outright markets down around 10 cents, the MGE premium increased by around 4 cents. My strategy was to sell this premium strength as the factor sending the wheat market lower--strength in the dollar --is not particularly good for hard wheat vs soft wheat. So I thought I would be able to scalp a penny or two on the "noise."
Didn't turn out that way.
Even though the outright market stabilized above the morning lows, the premium for MGE did not fall back, but rather, crept out farther. Nobody likes to take a loss, so I reversed the morning's December intermarket spreads in the nearby May contracts and will try to unwind the calendar spreads that result with the view that the CBOT contango will steepen much more than the MGE. Tomorrow we'll see if this was an elegant maneuver or just pathetic flailing when cornered.
Didn't turn out that way.
Even though the outright market stabilized above the morning lows, the premium for MGE did not fall back, but rather, crept out farther. Nobody likes to take a loss, so I reversed the morning's December intermarket spreads in the nearby May contracts and will try to unwind the calendar spreads that result with the view that the CBOT contango will steepen much more than the MGE. Tomorrow we'll see if this was an elegant maneuver or just pathetic flailing when cornered.
Wednesday, March 3, 2010
A Little More Background on Wheat Spreads
The fundamental reason for the appeal of Minneapolis and Kansas City wheat futures at small premiums (or discounts) to Chicago wheat is that both call for delivery of wheat with higher protein content. A more legalistic approach is that they both represent wheat deliverable against the Chicago CBOT contract without penalty. The MGE and KC contracts could be worth less if they represented "stranded" wheat that had no outlet, but the Mississippi River is still flowing today and will likely be flowing tomorrow, so that does not look like a real problem. Another reason for a Chicago premium would be that there is specific demand for "soft," low protein wheat.
The supply/demand balance for Chicago soft red winter wheat does appear tighter than the outlook for the much larger hard red winter wheat markets represented by the MGE and KC futures. But the prospect of a soft wheat shortage is remote as demand would shift to higher protein wheat if it were offered at a discount and the hard wheat is deliverable against the CBOT futures. So the CBOT could go to a premium that reflects the cost of transporting wheat to their delivery points (Chicago, Toledo) in excess of the cost of delivering to MGE or KC elevators.
In fact, I don't believe that the supply/demand balance for soft wheat is an important factor driving the intermarket wheat futures spreads today. The major issue is that CBOT wheat futures have been diverging from the underlying cash wheat market for several years. To the extent that the futures become unhinged from the physical market, it becomes impossible to make any fundamental forecast about their price relative to other instruments. The CBOT has recognized this problem and has implemented VSR (variable storage rates). While VSR may not have a big impact at first, within 6-12 months the onerous terms for storage without "loading out" physical wheat will force the futures to converge with the physical and the normal intermarket wheat spread relationships based on protein content will reassert themselves.
The supply/demand balance for Chicago soft red winter wheat does appear tighter than the outlook for the much larger hard red winter wheat markets represented by the MGE and KC futures. But the prospect of a soft wheat shortage is remote as demand would shift to higher protein wheat if it were offered at a discount and the hard wheat is deliverable against the CBOT futures. So the CBOT could go to a premium that reflects the cost of transporting wheat to their delivery points (Chicago, Toledo) in excess of the cost of delivering to MGE or KC elevators.
In fact, I don't believe that the supply/demand balance for soft wheat is an important factor driving the intermarket wheat futures spreads today. The major issue is that CBOT wheat futures have been diverging from the underlying cash wheat market for several years. To the extent that the futures become unhinged from the physical market, it becomes impossible to make any fundamental forecast about their price relative to other instruments. The CBOT has recognized this problem and has implemented VSR (variable storage rates). While VSR may not have a big impact at first, within 6-12 months the onerous terms for storage without "loading out" physical wheat will force the futures to converge with the physical and the normal intermarket wheat spread relationships based on protein content will reassert themselves.
Hardly Worth Mentioning
The intermarket wheat futures spreads traded in very narrow bands, very close to yesterday's levels. May MGE 11.5 to 12.75 over CBOT and KC at 2.75 to 4 cents over CBOT. Contangos narrowed a smidge; Dec10/Dec 11 CBOT was a penny narrower than yesterday's 80 cents.
Within the first hour the outright market looked like it was setting up for a further rally after a higher opening. A market profile (bell curve) chart showed the market staying up close to the highest levels of the first hour. My forecast for the day was that higher CBOT levels would lead to the hard wheat futures premium narrowing, but that there would not be any significant, lasting intermarket spread changes. So I was trying to sell MGE at 12.75 and buy it on a dip to under 12. The MGE sales I got done were “autolegged” at 12.05 on a 12.75 order. On a separate dip, I bought KC at 3.5 over CBOT which was a couple of cents off where it was Tuesday. Toward the close the MGE softened and I bought them back at 11.70 over, while I held the KC long vs CBOT as a new position. I have been long MGE vs CBOT at the outset of this journal (since December).
To summarize, I thought there wouldn't be much intermarket spread movement and there wasn't. But there were no rewards for this insight as the movement was not even really tradeable.
Within the first hour the outright market looked like it was setting up for a further rally after a higher opening. A market profile (bell curve) chart showed the market staying up close to the highest levels of the first hour. My forecast for the day was that higher CBOT levels would lead to the hard wheat futures premium narrowing, but that there would not be any significant, lasting intermarket spread changes. So I was trying to sell MGE at 12.75 and buy it on a dip to under 12. The MGE sales I got done were “autolegged” at 12.05 on a 12.75 order. On a separate dip, I bought KC at 3.5 over CBOT which was a couple of cents off where it was Tuesday. Toward the close the MGE softened and I bought them back at 11.70 over, while I held the KC long vs CBOT as a new position. I have been long MGE vs CBOT at the outset of this journal (since December).
To summarize, I thought there wouldn't be much intermarket spread movement and there wasn't. But there were no rewards for this insight as the movement was not even really tradeable.
Tuesday Recap
The intermarket wheat futures spreads, MGE & KC vs CBOT, traded in narrow 1.5-2 cents bands for the day with the direction provided by the swings in the more volatile CBOT market.
Overall, the wheat markets were very weak when compared to the significant gains in oil and gold and equities and currencies. This weakness looks to be an extension of Monday's price drop on the back of poor export results. CBOT calendar spreads widened (larger contango) modestly. I took the opportunity to sell Sep/buy Dec and to sell Dec10/buy Dec11.
Overall, the wheat markets were very weak when compared to the significant gains in oil and gold and equities and currencies. This weakness looks to be an extension of Monday's price drop on the back of poor export results. CBOT calendar spreads widened (larger contango) modestly. I took the opportunity to sell Sep/buy Dec and to sell Dec10/buy Dec11.
General Approach to Wheat Trading
The fundamental trading anomaly that I am trying to exploit relies on the differing slopes of the forward curves of the KC and Minneapolis (MGE) wheat contracts vs the Chicago contract. The introduction of Variable Storage Rates (VSR) has forced the CBOT contract to a significantly steeper contango than either of the other contracts. The effect of the higher contango is to push CBOT wheat to a premium to the others as one moves out along the forward curve. However, there is no reason to think that CBOT wheat will actually retain this premium through the actual delivery date.
Right now MGE is about 12 cents over CBOT for May 2010 delivery, 2 cents over for Dec 2010 delivery, and 15 cents under for Dec 11 delivery.
While the obvious play is to buy the Dec 11 MGE at a 15 cent discount and hold to delivery, there may be a significant amount of pain along the way. In particular, the MGE contango is very close to a 100% of full carry (allowing full storage costs and 3.25% financing), but with the new VSR regime at the CBOT, the Chicago contango could reach much higher levels. The Dec10/Dec11 Chicago spread is around 80 cents, implying that the VSR will be less than 8 cents/month. Assuming that VSR is bumped up from 5 cents to 8 cents on the July/Sep 2010 spread, the spreads would have to trade at less than 50% of full carry some time between Dec10 and Dec11 in order for the storage rate to drop back to 5 cents/month. Further, this does not include the possibility of a further VSR bump up to 11 cents/month (nor further bumps). Given that the VSR is calculated over the last month before notices, which includes the index rolls, it is very possible that the VSR increases will be triggered and the contango steepens--soooo, it is not an easy or safe trade to short Dec11 CBOT wheat against other wheat contracts that can still rely on fixed storage rates.
My view is that it is better to stay closer to the front end of the curve, within 2010, for intermarket spreads and look for the eventual drop in the nearby CBOT futures as the storage fees begin to mount.
Right now MGE is about 12 cents over CBOT for May 2010 delivery, 2 cents over for Dec 2010 delivery, and 15 cents under for Dec 11 delivery.
While the obvious play is to buy the Dec 11 MGE at a 15 cent discount and hold to delivery, there may be a significant amount of pain along the way. In particular, the MGE contango is very close to a 100% of full carry (allowing full storage costs and 3.25% financing), but with the new VSR regime at the CBOT, the Chicago contango could reach much higher levels. The Dec10/Dec11 Chicago spread is around 80 cents, implying that the VSR will be less than 8 cents/month. Assuming that VSR is bumped up from 5 cents to 8 cents on the July/Sep 2010 spread, the spreads would have to trade at less than 50% of full carry some time between Dec10 and Dec11 in order for the storage rate to drop back to 5 cents/month. Further, this does not include the possibility of a further VSR bump up to 11 cents/month (nor further bumps). Given that the VSR is calculated over the last month before notices, which includes the index rolls, it is very possible that the VSR increases will be triggered and the contango steepens--soooo, it is not an easy or safe trade to short Dec11 CBOT wheat against other wheat contracts that can still rely on fixed storage rates.
My view is that it is better to stay closer to the front end of the curve, within 2010, for intermarket spreads and look for the eventual drop in the nearby CBOT futures as the storage fees begin to mount.
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