No Love for Wheat Today

Very sharp move lower in wheat markets today, led by KC wheat. Works for me.

It was interesting to see July/Sep KC wheat move beyond what I see as a full carry contango. If July KC is at more than 16 cents discount to Sep, then I think it is very likely that the market is factoring in quality issues on July contracts.

Full financial carry on July/Sep CBOT has a lot of moving parts, but if storage rates stay the same, then it would be about 43 cents. If the spread averages something like 44 cents in the weeks approaching July delivery then the storage rates bump up again, and full carry will be pushed out toward 50 cents. The July/Sep CBOT is now 45 cents.

Both the KC and CBOT July/Sep calendar spreads contrast sharply with the MGEX situation--though slightly softer, July again closed at a premium to Sep on the MGEX.

July/Sep MGEX Shoots to Backwardation

I have a hard time believing that supply will really be that tight come July...but I also have a hard time believing that the cash DTN index for Hard Red Spring wheat is more than 50 cents over May futures and yet it's been there for some time now.

The biggest problem trading the intermarket spreads at the moment is that each has a bullish story and the stories are all quite different. We got lucky that there was some rain in the Hard Winter Wheat areas to dampen the bullish story there and help our long July MGEX vs KC position. There are still other drivers that could increase the MGEX premium to KC and we saw some come into play today as July/Sep MGEX inverted (to July premium) while KC July/Sep pushed out to 100% of financial carry. I have noted in previous posts that KC July/Sep would be subject to the extraordinary factor of a contract spec change on the Sep contract, so that can go well beyond 100% of normal financial carry charges.

MGEX July/Sep Indicates Some Tightness

If markets are any good at rationing demand through price, then the July/Sep MGEX calendar spread trading in close to even money should be a strong indicator that supplies of July hard spring wheat are going to be fairly tight. While there are many supply concerns around the KC hard winter wheat based on the poor growing conditions so far, there are reasons to avoid holding the July KC contract: 1) even a small crop will add to the current full-carry inventory, and 2) July KC will be the last best chance for elevators to rid themselves of grain that won't meet September 1 contract specs (though it's possible that elevators could rid themselves of poor quality inventory through careful blending, that would take time and expense).

So, yes, I like my long July MGEX vs KC position and added to it today.

Wading Back In

Spent the day buying dribs and drabs of MGEX July and Dec vs both KC and CBOT. It's hard to express exactly why. Perhaps because the July/Dec MGEX looks far more bullish than any CBOT or KC calendar spread. Perhaps because cash Hard Red Spring wheat continues to trade at large premiums to all both hard and soft winter wheat. We'll see how it works out.

Could Be a Long Breather...

Soft Wheat is perhaps now supported by parity with corn. Hard Red Winter Wheat is supported by current lousy crop conditions. And Spring Wheat is supported by the big premiums being paid in the cash market. I can see any or all them as bull markets, but they've all been trading down recently. So I'm not too comfortable with any spreads among the bunch.

Taking a Breather

What Do I Know?

I decided that I've been over-thinking the intermarket spreads lately; who knows where the July MGEX/KC spread will go? I don't like the July KC contract, but it's entirely possible that all the negatives I see will be reflected in a weak basis for cash vs futures and KC futures will skyrocket. I'm not willing to bet on it right here. So I squared up my positions.

Will try taking a fresh look at things tomorrow without being under the influence of an existing trading position.

If Wheat Is Falling, Why Are Calendar Spreads Narrowing?

As I type, CBOT wheat has dropped about 50 cents in 48 hours. But over that period, May/July has tightened from May at 36 cents discount to only 32. So if the nearby supply/demand looks tighter, why is the market dropping? I have to guess it's because other commodities like oil (down $7/bbl over the period) are influencing macro and portfolio investors.

The same dynamic applies to MGEX as well. While there has been a steep sell-off in the outright market, the May/July spread is less than 60% of full carry--and July/Sep is nearly at even money.

Big Moves in Wheat Intermarket Spreads

And the big moves do not appear to be related to any particular news...just market gyrations. The MGEX vs CBOT spread has crashed 40 cents in 3 days. But I said last week (at the highs) that there was certainly room on the downside. On the other hand, MGEX vs KC has only fallen back to the levels we saw at the lows last week. So that was indeed the lower risk spread. So where from here?

If all wheat is now going to be viewed as a potential substitute for precious, scarce corn --that seems to be the source of support for CBOT wheat, though it's really just a plausible guess-- then the MGEX premium to CBOT could shrink further, even a lot further. But the 10-15 cent premium for July MGEX to KC looks cheap even from that point of view. And Dec MGEX at a discount to KC? Would anyone really want a long-term position betting that KC will go to, and stay, at a premium to delicious, 13.5% protein HRS wheat?

Where from Here?

Friday's trading saw both a market reaction to bearish news in corn and step toward normalization of intermarket spreads in wheat. While traders that are long corn futures seems relatively undisturbed by Friday's WASDE report, corn underperformed other grains and commodities in general. On the whole, the bullish prospects for the new crop still shine and there isn't that much old crop left.

In the wheat market, a dramatic drop in the premium for KC over CBOT was the feature of the day. A little precipitation and a little extra inventory in the WASDE and the KC futures took a big hit. I am not a bull on the July KC against anything. For a lesson on how the changing contract specs can affect a futures market, just take a look at July/Sep rice. And while new crop CBOT wheat is going to be very well supplied, it is already very cheap--practically even with corn. So there is support there that KC will not have.

The main opportunity that I saw Friday was that July MGEX dropped to below $1.30 premium to CBOT. Given that there may be continued pressure on the above-mentioned KC/CBOT spread, I decided to wait and see if that gets cheaper before jumping in.

Haven't Really Traded for Two Days

The long July MGEX/ short KC spread has been drifting mostly higher, it was running about 15-18 cents premium MGEX today. I tried to jump in at the close and buy some July MGEX at $1.40 over CBOT but only got a couple before the bell.

Calendar spreads are still hanging around the same levels as when I rambled on about them a few days ago...

The trade I missed was the $105,000 MGEX membership--I wanted that one. But stepping back, I have to admit that over the 15 months since I first got involved in MGEX, the memberships have appreciated precisely 0%. Obviously, if I had it to do over again, I would go with the dividend paying KCBT membership.

Back to the Intermarket Wheat Spreads

Apparently, I couldn't stand the easy life being long July MGEX/short CBOT wheat, so,as I mentioned last week, I have been shifting to long July MGEX/short KC. While the trend is certainly strong on the former, I think there will be less volatility and better value in the latter.

I'm as bullish on July MGEX as anyone, but being short July CBOT wheat which is nearly even with corn doesn't seem risk free. And we were around $1.50 premium for MGEX today, so while that could be a lot higher, there could be more than a few cents on the downside.

Compare that to owning MGEX at 12-13 cents premium to July KC. Could it go to a discount? Sure. But I don't see MGEX staying at a discount. There won't be any shortage of hard red winter wheat in the first new crop month on KC. On the other hand, old crop July MGEX is nearly even with new crop September. Throw it the usual protein premium for MGEX and the changing contract specs for KC (July will be the last chance to deliver low-protein, high vomitoxin wheat on the KC) and everything I see favors MGEX.

A Little More on Wheat Calendar Spreads

The CBOT, like the KCBT, is adjusting its contract specs for the September contract with respect to vomitoxin levels. From the CME SER:

The vomitoxin level for par delivery in the July 2011 contract, 3 ppm, will be deliverable at a 12 cent per bushel discount in the September 2011 contract...Because of this change in value, the 2011 July – September Wheat spread may expand (September increase relative to July) up to 12 cents per bushel beyond the quantity of the spread absent the change in vomitoxin specifications.

The CME goes on to say that they are adjusting the July/Sep VSR calculation to account for this "extra" premium for September contracts which is not due to storage, but due to quality difference. As far as I can see, the market has not allowed for anything like 12 cents difference in quality; possibly, this is because there is no grain in storage that is over the September limits, but that seems unlikely to me. I believe the additional premium for September contracts may apply just as much (if not more) to the KCBT as the CBOT, since they are making a similar change in delivery terms, though I don't believe that anything over 2 ppm will be deliverable against KC at any price.

Some Thoughts on the Wheat Calendar Spreads

A few months ago the KCBT finalized changes in their wheat contract that will take effect with the September contract. As I look at the contract specs, I think full carry for July/Sep is about 15.7 cents using 3% for financing. Previously, I had thought the carry was 18 cents plus financing, but reading the KCBT rules, it seems the higher storage rate does not take effect til September 1.

There is another change to the rules that takes effect in September and that is a tighter restriction on acceptable levels of vomitoxin and protein. So if you are running an elevator that is regular for delivery you need to dump all the wheat that will not comply with the new regulations before September 1.

If you are just a financial participant, the actual quality of the underlying wheat should not impact the value of the shipping certificate. But if you are looking at loading out wheat, you would apply some premium, perhaps substantial, to the September contract over May or July due to quality.