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.