Whither Dec/March Calendar Spreads?

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

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

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

Light Posting Due to "Vacation"

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

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

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

More Bear Market Dynamics

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

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

Some Speculation on Ethanol

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

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

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

Short Day

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

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

Wheat, and Wheat Spreads, Bouncing

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

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

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

Waiting for the Ukrainian rain.

Not much to talk about today...

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

Same Post as Yesterday, More Steps Back toward Rationality

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

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

More Baby Steps...

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

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

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

Another Baby Step Back

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

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

We Are Still a Long Way from Normal

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

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

No Trading Today

Another Step toward Normalcy

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

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

Creeping Back to Sanity

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

Was that the Top?

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

Futures Unbound

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

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

Taking a Breather...

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

So, for now we go flat.

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

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

Even on a Down Day, the CBOT Wheat Outperforms

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

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

Big Dislocations

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

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

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