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.