More Pain...

Mar12 KC wheat futures fell to 48 cents premium to CBOT today; not a big surprise since the tone of the market was set by outside markets rallying on central banks easing policy--so more positive impact on the speculator-sensitive CBOT contract.

At the front end of the market, the Dec/Mar KC spread tightened notably and there were reports of cash wheat trading at a premium to Dec11 KC contracts.

I did not add at better levels.

In some additional painful news, MF Global appears to have hit the bid for 1 MGEX seat at $106,000 and may have 3 more to sell...with the best bid now only $80,000. Distressed seller of MGEX seat with the rest of the equity market up 6% in 3 days. Looks like an opportunity.

CBOT Short-Covering Dominates

MGEX and KC wheat futures failed to keep up with the rally on the CBOT. The Mar12 KC premium has dropped from around 70 cents to just over 50 cents; March MGEX has fallen 50 cents versus CBOT--from near $2.70 to $2.15.

The CFTC reported that short interest continued to grow on the CBOT wheat futures. Further, via Twitter we had Al Conway (http://www.cashwheatreport.com) speculating about more passive index buying for the new year:

CFTC CIT (sic) report shows wheat funds record short 86 K contracts & Index fund reallocation suggest they buy 42 K contracts wheat in New Year.

Also we saw inventories build slightly at Duluth for MGEX. The premium for Dec11 to Mar12 which was as high as 85 cents/bushel, crumbled to 5 cents (flat at one stage today) going into the First Notice Day tomorrow.

So, overall, there isn't much bullish news out there. Wheat inventories are substantial; the weather is good; the US dollar is strong. However, the non-commercial players are short and the longer term investors are under-exposed. It's a situation where a rally could fuel further rallying.

But I'm not willing to bet on (or wait out) a rally. We have only seen March12 KC at levels this cheap versus CBOT a couple of times over the last 4 months. There is much more room for the CBOT contango to steepen than there is for KC. Eventually the large inventories (CBOT's Soft Red Winter Wheat has the highest stocks/use ratio) will eventually take their toll--especially if even more index investors get on the long side. So I am keeping and adding to my long Mar12 KC vs CBOT position.

Writing Before the Close...

Dec11 MGEX wheat has dropped 80 cents/bushel vs CBOT in just the last 4 sessions. It is now about 65 cents/bushel below where it was when I noted that the MGEX premiums were too risky for me. I should note that I was not not long the Dec11 MGEX anyway, but rather the March12 and July12 MGEX which are only about 15 cents lower and unchanged respectively versus CBOT. I am still patting myself on the back for avoiding some extra volatility...

Brain Cramp!

Amazingly, even as the backwardation in MGEX calendar spreads collapsed yesterday--knocking nearly 40 cents off the Dec11 MGEX premium to CBOT--I never checked the Tuesday morning release of deliverable stocks for MGEX. If you follow the link and open the spreadsheet, you will see that stocks rose slightly. Quite a reaction from the market.

The reason I missed the MGEX report is that my focus is more on KC vs CBOT because that's where my money is. That market was not remarkable at all. Perhaps there was some spillover selling of KC and buying of CBOT caused by the large MGEX move, but the KC-CBOT intermarket spread closed unchanged.

After Further Review...Climbing Back into KC Wheat

While I'm leery of the large premium for high-protein spring wheat, and I'm sure the difference in storage costs between MGEX and CBOT offers little protection at these levels of the intermarket spread, I re-established a long KC versus CBOT position. March KC at 68-70 cents over CBOT isn't a crazy level.

My worries about short covering on the CBOT are still present, but there's no reason that has to turn around any time soon.

My email address is in the "about me" section on the lower left side of the page.

More Comments on MGEX Backwardation

Due to lack of space under a previous post, I will continue the conversation on MGEX backwardation here.

The basis between cash Hard Red Spring Wheat and Dec11 MGEX futures does not seem unusual: the cash is about 25 cents under the futures. The MGEX charts are here:
http://www.mgex.com/charts.html?page=mspread&cc1=MW&spr1=MWZ11&mon1=Z&year1=11&cc2=IP&spr2=IPY11&mon2=Y&year2=11&size=b&den=high&jav=adv&data=A&expm=0&date=111811&code=xmri&org=com&crea=Y&sprd=Y&button=Create+Spread

With MGEX deliverable inventories at the lowest levels in many years, it isn't surprising to see MGEX futures at big premiums to other wheat futures. However, since there are 12MM+ bushels in storage, why is the market in backwardation? I think the only explanation is that buyers are willing to pay a "control premium." As Ken has pointed out in comments, there wouldn't seem to be any source of more inventory over the next 6 months. So buyers are willing to pay up for the current inventory stock.

So why isn't the backwardation steeper for March12/May12 and the more deferred spreads until the new crop comes to market in Sep12? I believe that there is some chance that the very high prices for Hard Red Spring Wheat in Duluth will simply kill demand. Within the last 5 years we have seen 2 instances where the deliverable inventories grew over the period from November (after the harvest) to the following August--2006-7 and 2009-10. It isn't certain that the market will tighten as inventories are consumed; supplies will continue to trickle in, while exports and domestic consumption will be constrained by high prices.

That's my take on it. Sadly, Ken, the only view I have from my MGEX seat is of anonymous electronic screens--I don't see any customer flows whatsoever. I am purely a prop trader using public data.

Finally, I'm going home flat tonight. While I still favor KC over CBOT, the forward curves are not so different at this juncture. If one accepts the spread in cash markets to be a fair price, then going out to July only gives the KC longs a 15-20 cent advantage (47-48 cents premium for July12 KC vs CBOT as opposed to 65 cents in current cash markets). With the prospect of a surge in CBOT futures prices powered by short-covering, I would rather wait and see.

MGEX Is Apparently Bulletproof

Why, oh why, didn't I stay long the beautiful MGEX?

Really, I won't lose sleep over it. I have been surprised that the premium for KC over CBOT has not grown as the overall wheat market has seen prices drop. I assume that CBOT wheat is seeing more speculative selling..maybe the prospects for better growing weather in the Hard Red Winter Wheat growing areas has had a negative impact on KC prices. Or maybe CBOT shorts are providing a bit of a floor to that market (doubtful).

Anyway, the July12 KC remains close to 50 cents premium to CBOT, so there hasn't been much to get excited about.

KC Wheat Struggling

My conservative move into long KC wheat vs CBOT (from my former long MGEX vs CBOT) delivered nothing but misery today. July 12 KC drifted down to around 48-49 cents premium to CBOT--after opening higher at 55-56 cents premium. I continued to add long KC vs CBOT.

CFTC COT report showed very high levels of CBOT shorts (45K) and the Dec CBOT firmed sharply on the calendar spreads. So that's sums up the tough part of shorting the CBOT. On the other hand, Cash markets premiums for protein remain very firm and cash Hard Red is around 80 cents over Soft Red. So the fundamentals seem friendly enough.

New Twist on My One Wheat Idea

The reason I trade MGEX wheat is that I believe the passive commodity index investors distort the pricing of the wheat futures on the CBOT in significant ways. The general idea, especially after the CBOT instituted the VSR regime, was to hold the low cost of carry MGEX wheat while shorting the high cost of carry CBOT wheat.

This has been a very good strategy--but not entirely for the right reasons. The MGEX has been far stronger than just "low cost of carry," it has develop3ed a persistent and substantial backwardation. We now see premiums for nearby MGEX wheat futures to CBOT that have occurred very few times over the last 100 years. Maybe they will go higher, maybe not. The thing is, analyzing the degree of tightness in Minneapolis wheat is not really my game.

So I have liquidated my long MGEX vs CBOT positions and will replace them with long KC vs CBOT positions. For now, I nibbling away at July12 KC at just over 50 cents premium to CBOT.

PS. The CBOT calendar spreads have been liquidated, since the Goldman roll is nearly over and the spreads narrowed to realistic commercial cost of carry levels.

New Data, New Theory on MGEX Wheat

Yesterday's rally in MGEX wheat futures was not likely related to MF Global liquidation, since open interest rose sharply. Therefore, yesterday's buying of MGEX futures, included deferred contracts like Dec12, represented new positions.

So I ventured out to re-establish long MGEX positions in March12 and July12. The levels aren't exactly what I would like, but they are a lot cheaper than cash levels for Hard Red Spring Wheat. I am beginning to shy away from Dec12 due to the rules change which allows non-US origin (Canadian) wheat to be delivered. If Canadian wheat is allowed, then I can only assume (with greater supply and unchanged demand) that prices may drop.

Every Dog Has His Day

In what appeared to be some MF Global related activity, MGEX premiums to CBOT jumped 15-30 cents higher near midday before closing back close to unchanged. With the USDA report out tomorrow, it was a good opportunity to liquidate all my MGEX versus CBOT spreads--especially out in Dec12 where the market went to around $1 premium for MGEX from yesterday's close of 70 cents.

Also liquidated all my CBOT Dec/Mar spreads at that contango narrowed to to about 22 cents from last week's 35-36 cent level. While traders normally expect the "Goldman roll" of passive index long positions to drive the contango to steeper levels, there are many fewer longs to roll this time around--about 60K fewer as index positions are smaller and non-commercials are about 40K contracts short.

Calendar Spreads Dominate Wheat Futures Trading

The contango on CBOT wheat continued to shrink today with a scramble at the closing bell. And the Dec11/Mar12 backwardation increased on MGEX to over 65 cents. The intermarket spreads were somewhat mixed with the MGEX weakening on all but the nearby Dec11 contract. Given that the outright markets traded around the unchanged level for much of the day, I didn't regard the drift lower on the MGEX intermatket premium as being significant--cash levels for Hard Red Spring Wheat stayed very strong.

Not Much Impact from MF Global on MGEX Wheat

MGEX calendar spreads and its intermarket levels versus CBOT are not much changed in the wake of the MF Global fiasco. I continue to keep low risk levels generally. The short squeeze on Dec11 CBOT shorts is not spectacular so far, but the Dec11/Mar12 contango is narrowed 3 cents today, so it may be developing.

MGEX Wheat Creeps Higher vs CBOT

As the Euro-phoria of late last week fades, downward pressure on CBOT has grown. With commodities markets generally falling, the CBOT has seen the bulk of the speculative selling. MGEX, on the other hand, reported declining inventories in both Duluth and Minneapolis indicating that the peak storage numbers after the harvest have already been seen. The backwardation of Dec11 over March has softened, but cash market premiums for hard wheat over soft are continuing at elevated levels.

All in all, it looks like a good time to hold MGEX wheat vs CBOT, especially out past the nearby, very expensive Dec contract.