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.

Still Waiting for the Rally

Because the CBOT wheat contract typically sees higher volatility, the hard wheat/soft wheat spreads often act as bull/bear spreads driven by the overall direction of the wheat market. While we generally prefer being short the CBOT on spreads against KC and MGE, it can be painful during market rallies when the CBOT's trend-following shorts pay up to cover. So we've been waiting for wheat to bounce to put on new positions. It hasn't bounced much.
The USDA numbers were mildly positive for wheat--slightly smaller leftover old crop. The big number was a hike in the amount of corn used for ethanol. Didn't really move corn much--or ethanol. In fact the small rallies in grains could be explained by the weaker USD rather than any buying on USDA fundamentals or short-covering.

Anyway, intermarket spreads didn't move much and we are still looking for a bounce--even going home long July CBOT/ short KC. The DTN cash Hard Winter Wheat index, for the variety normally delivered to KC, has weakened to $1.16 under July KC. That is only 1.11X the cash corn index. At those levels wheat should start getting included in animal feed. You can probably make ethanol out of it at those levels. A basis level that weak is very painful for farmers (hedged and unhedged) and indicates a futures contract that is not serving its main function effectively.

Wheat--A Bear Market that Makes the Euro Look Strong

A weaker USD, rising equity/risky assets, Bernanke vowing to drop cash from helicopters, stronger corn and bean prices--none of it stopped wheat from making fresh lows. The calendar and intermarket futures spreads were very little changed and we liquidated most of our positions. There are USDA numbers out tom'w morning and we weren't in our short KC/ long CBOT positions for the long term anyway.

Both the KC and CBOT July/Sep spreads are trading at about 3 cents beyond exchange storage costs. Delivery and re-tender costs me 2 cents, so I'm not doing anything in it right now. There are 2 more days in the Goldman roll period. If we can get something like a penny more than the market is offering now (net 2 cents), we can buy July/sell Sep and lock in 2.5% at worst. The yield will be higher if we trade out of it earlier or roll again Sep/Dec, amortizing the re-tender costs over a longer period--something closer to 3.9% if the market is priced similarly in Sep. On a July/July11 carry, one could lock in 3.5% after costs right now. That's pretty high, but there is some risk that the KCBT could change their storage rates in similar fashion to the CBOT's VSR--remember, the VSR was instituted to fight the large cash/futures basis that the KC is currently experiencing.

Grains Threaten to Rally, Flop at the Close

The wheat market spent most of the day in positive territory, with the Euro marginally up and equities at least not falling too much. A sell-off in the last 5 minutes put the market back to unchanged.

Calendar spreads remained at very steep contangos and intermarket futures spreads favored harder wheat over softer wheat-July MGE in particular touched new highs against the CBOT.

Despite the same factors driving the market, I am still more cautious than a month ago. Sure the strong USD should knock wheat down, but wheat is down 15% in the last month on a 10% move in the Euro. The only other bearish development has been the good weather- but with the big inventory, the market never priced in much,if any, weather risk anyway.

Looking More at KC Wheat

Today's trading didn't work out so well. I have been trying to shift away from the short July CBOT/ long anything else strategy that has been driven by the CBOT's VSR regime. As the CBOT contango has grown way beyond KC and MGE, there seems to have been some real impact on grain movement. The VSR was instituted to force the basis back toward zero at the CBOT; the cash/July basis is inside of 50 cents for CBOT wheat after having been over $1 for the previous few years. Meanwhile, it is the KC cash/July basis that has blown out over $1. Cash Hard Red Wheat is trading around 25 cents below Soft Red Wheat.
There may be a number of factors driving the cash market: the supply/demand balance sheet is tighter for soft wheat (small crop, decent exports), and the hard winter wheat market is suffering from some quality issues. Still, there are very few sustained periods of demand for low protein, soft wheat at a premium to higher-protein, hard wheat.
My trading thesis is that the July KC futures premium (about 30 cents over July CBOT) is due to substantial index longs and very few non-commercial shorts--in contrast to the CBOT which continues to attract new trend-follower shorting. This is not a "core" position and we will exit if the KC premium increases to new highs--which is entirely possible if the wheat market continues to head lower. For a down market in outright wheat prices, we are also short KC against MGE. Again, we are only going to sit with this for a few cents against us because if the July KC futures are just becoming unhinged from cash markets, they really could go almost anywhere.

No Trading Today

I spent the day learning how to use CQG's Spreader. Hopefully, we will see improved fills. If the execution are really good, perhaps we can try to execute more intra-day scalping. One interest thing was that ethanol futures didn't work at all in their Spreader (at least not against corn); it took support staff about 30 minutes to sort out some bugs. This indicates they have about zero customers trying to execute that spread.

Wheat Harvest Underway

Any prospect of weather concerns for the winter wheat crop are fading fast as Georgia is 20% in, and Texas around 6% done. Wheat again finished at new lows on the CBOT. Spreads were not much changed, though July MGE got as high as 58 cents over CBOT even when the outright market was up on the day--so there was some buying interest there.

The Hard Red Winter Wheat basis remains very weak with cash wheat trading at $1.07 under the KC contract. This is very painful for producers who are not getting the full benefit they would like from their KC hedges. I don't have an explanation for why or how cash Hard Red Winter Wheat is trading at a significant, 28 cent discount to Soft Red Winter Wheat. There is certainly no shortage of Soft, since the CBOT and the KC are both trading at full carries. In fact, you would have to wonder if the higher, VSR storage rates that can be earned on CBOT soft wheat forward hedges are inducing growers to hold back from selling cash soft wheat. In other words, the steep CBOT contango hurts longs that are holding positions on the exchange or physical certificates for exchange delivery, but the steep contango makes it attractive for producers to hold wheat in storage off the exchange.
While the CBOT instituted the VSR regime to force holders of certificates to sell, the impact on hedgers may be the opposite--the VSR induces them to hold Soft Wheat in inventory.

I liquidated the long ethanol/short corn position we had. It was profitable, and could keep going, but I am not comfortable with the short corn side of the trade right here. We added long July MGE/short KC to our long July11 MGE/ short CBOT. These may also be skewed towards working better in a bear market and I don't want a lot of directional bias at the moment.

All the Wheat Trends Extend...

Wheat lower. CBOT forward wheat curve steeper. MGE and KC wheat at increased premiums to nearby CBOT.
Corn, after months in a narrow range, has also broken down to new lows.

Again, we are not going to fight any of these trends in wheat. In fact, we are trading wheat primarily because of these market dynamics. However, as we see speculators shorting the new lows, it's useful to remember that the "USDA believes the 2010 SRW [Soft Red Wheat-CBOT] crop will yield the nation's smallest harvest in 32 years." {DTN Grains Edition}

The idea that speculative short-covering will eventually emerge to push the CBOT back higher vs MGE and KC is an important check on maintaining large intermarket spread positions on a long-term basis. (Though I wish we had our old positions today.)

Wheat Makes New Lows

CBOT wheat continued to fall both in outright price and in relation to MGE and KC. Calendar spreads steepened back toward the highest contangos yet for July10/July11. The USD remains strong, weather looks good, farmers are starting to look at some tough times:
Farmers Facing Lowest Wheat Prices In 5 Years

I'm not going to try to call the bottom on wheat, and we did dip in a toe on a new long July11 MGE/short CBOT intermarket spread at 9 cents premium MGE, but I'm not thrilled about putting on bear spreads at these current levels. The CFTC COT shows that trend-followers continue to establish new shorts, while indexers also trimmed longs, with commercial buyers taking it all in. Sure, if commodities as an asset class are liquidated, then index liquidations could pressure wheat down 10-15%. Or if the USD appreciates significantly from here, US wheat prices will have to drop to maintain exports. But with China loading out cargoes of corn and cash Hard Red Wheat priced at 1.15X corn, I think some of the wheat is going to start to disappear.