Kub's Den

The snowstorm rally in wheat at the start of this month has already been well-covered by DTN's reporting staff, and of course, by its grain market analysts, so I almost hate to pile on with more talk of wheat. But it's only now after prices have waxed and then waned back to pre-snow levels, that the data can show us something universal about grain markets. It's a lesson that corn and soybean traders (and producers and end users) should keep in mind while we're heading into the season when sudden weather shocks can hit U.S. row crops, too.

Market analysts bemoan the rise of algorithmic trading whenever it seems like human patterns of fear and anxiety and aggression and competitiveness seem to have fallen by the wayside, tamped down by the passionless rationality of computer calculations. This is especially true in the stock markets, but commodity analysts worry about it, too. However, the commodity markets still have one fantastic tool to see what some human market participants are really thinking about a market's supply and demand. That tool is the carry spreads.

The difference in value, or the "spread," between the futures price of a commodity from one month to the next can tell an observer how much money the industry is budgeting for the physical costs of storing that commodity. In some commodity markets (like oil), this is called "contango." But in grains, we call it the "carry" spread, i.e. the cost of "carrying" grain from one month to the next. In late April in the Kansas City wheat futures market, which represents physical hard red winter wheat of roughly average protein -- a commodity which is overabundant in the U.S. and throughout the world -- this carry spread was approximately 8 cents per bushel per month. The futures price for September wheat was 16 cents higher than the futures price for July wheat (a two-month interval), and the futures price for December wheat was more than 40 cents higher than for July wheat (a five-month interval). In other words, once the new crop of 2017 wheat was harvested in July, physical wheat traders were expecting to be amply reimbursed for whatever storage facilities they could provide to get that wheat under shelter and kept into condition through the end of the year (and beyond).

If that spread value were to suddenly collapse (going from 8 cents per bushel per month to 6.8 cents per bushel per month, for instance), it would suggest that the market no longer expected such a huge upcoming crop of wheat, and that the supply and demand OF STORAGE SPACE itself would have suddenly become less bullish.

Well, that's what the spread did, and the timing of the collapse was fascinating. There were two serious wobbles in the July-to-December KC wheat spread. First, on Thursday, April 27, presumably as the weather forecasts for the weekend prompted some fear in the hearts of Kansas wheat merchandisers, and then the second more serious wobble at 6 a.m. on the Monday morning after the snowstorm. The storm damaged up to half of the Kansas winter wheat fields and could potentially lead to the abandonment of 20% of the state's acres (plus more in Colorado and Nebraska).

Take note: The actual explosion in the futures price for new-crop winter wheat didn't take place until 7 p.m. Sunday evening, reaching its peak around 3 a.m. the next day. The big push was made from 8:30 a.m. Monday morning onward. The spread traders led the rally by at least a couple of hours.

Of course, speculators can trade wheat spreads, too. It's entirely possible that a hedge fund or a mass of retail investors (or a computer algorithm with its inputs trained on Southern Plains weather observations) were the ones to cause that blip in the new-crop carry spreads. But in practice, it is the commercial traders -- the companies who own actual storage facilities, and who actually book profits based on how well they hedge those carry spreads and roll their hedges forward toward an ultimate delivery date -- who express their bullish or bearish opinions about wheat supply via futures spreads. It's effectively the only way those commercial traders -- the ones in the know, the ones with their boots on the ground in the actual countryside where the crop is growing -- CAN express their opinion and book trading profits, since they never let themselves be exposed to the flat price risk of overall market movement up or down. Meanwhile, most speculators find it more rewarding to take on flat price risk wholeheartedly, rather than dabbling in spread trades.

So there is a lesson: If truly new fundamental information is coming in to a grain market, look to the futures spreads to get the first read on that information. The spreads are where the human beings are still in control, and they are still reacting in that classic, bubbling, cascading, human behavioral pattern of Panic -- Re-evaluate -- Recede. Furthermore, they're capable of doing it faster than the headline-driven speculators can keep up. Wheat's reaction to the weekend snowstorm was especially interesting, coming after a weekend break in futures trading. What would the information cascade and the bubbling futures prices have looked like if the snow had arrived on a Wednesday night instead of a weekend?

Bear in mind that new information can still come in about U.S. hard red winter wheat production in 2017. The damage observations and the replanting decisions are still being made as this is going to print, and as the fresh monthly World Agricultural Supply and Demand Estimates are being processed by the market.

But ultimately, after the weather scare wore off, even for the commercial traders, those KC wheat spreads look awfully bearish again. The July KC wheat contract is right back where it started before the snowstorm -- below $4.40 per bushel. Same story for the July-to-December spread -- it's once again over 40 cents per bushel. The real human beings trading real, physical wheat out in the countryside may have been the first ones to register their fear, but they were also the first ones to recover their cool.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

(BAS/AG)

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