Generally when Chicago is priced over Kansas City an opportunity may be present to buy Kansas City and sell Chicago.

- Matthew Pierce

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May 25, 2007

Are you listening? You should be!

Walsh Trading is pleased to announce the Walsh Trade Voice (WTV) 2007 Cornbelt Snapshot Tour report has begun. With quality first hand information you cannot get anywhere else, the Cornbelt Snapshot can be heard live at 7:35 AM, CST on WTV and in its recorded version once the live broadcast is completed. The 2007 Cornbelt Snapshot Tour features input from 8 diverse locations throughout the entire U.S. Cornbelt. Listen now!

The concept of intermarket wheat spreading is and has been overlooked by many in the trade as intramarket spreads gain in both volatility and interest. The major difference between spreading wheat against wheat instead of wheat against corn or beans is the wheat contract differences established by differing deliverable specifications at different exchanges. Wheat has three separate domestic contracts where as beans and corn each have only one. Dark Red Spring wheat, traded in Minneapolis has the highest standard specifications while Hard Red Winter wheat, traded in Kansas City has the second highest and Soft Red wheat traded in Chicago the third highest. The contract specification of most interest is protein content or minimum percent protein contained. The minimum for Minneapolis wheat is 13.5% with 13% deliverable at a discount. Based off of delivery specifications and historical price patterns, the traditional spread is Minneapolis more expensive than KC and Chicago and KC historically more expensive than Chicago.

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Factors affecting these intermarket spreads are production, international and domestic demand, crop production quality and stocks on hand. Production is the first and most important factor in that lower production in any crop year should equate to a more expensive flat price as well as higher basis. The opposite side of this coin is a large crop consisting of poor quality wheat possibly not meeting minimum deliverable specifications. This pushes the affected wheat to animal feed usage, removing it from milling (human) consumption and deliverable consideration. This traditionally does not equate to a higher flat price move but cash basis rises due to diminished deliverability of the specific product. International demand is the second factor with demand for Hard Red Wheat and Hard Red Spring Wheat, the KC and Minnesota contracts respectively outweighing demand for the Chicago based Soft Red Wheat contract. This is due to international specifications for milling wheat that the Soft Red wheat contract does not traditionally meet. This factor strictly enforces the traditional wheat hierarchy. Crop quality is a factor in that a decrease or increase in protein content for any one category/contract of wheat may allow that wheat to be interchangeable as a deliverable commodity against opposing contract specifications. For example, you can authorize delivery of Hard Red Spring wheat against KC deliverable locations if you can figure out the actual transportation logistics of shipping Dark Red Spring wheat to a deliverable location for Hard Red Winter wheat. On the other hand, you cannot deliver Soft Red wheat against the Minneapolis contract specifications due to minimum standards not being met. The following is a display of the various varieties of wheat that can be delivered against the Chicago contract meeting minimum specifications: No. 2 Soft Red Winter, No. 2 Hard Red Winter, No. 2 Dark Northern Spring, and No. 2 Northern Spring at par; No. 1 Soft Red Winter, No. 1 Hard Red Winter, No. 1 Dark Northern Spring and No. 1 Northern Spring at 3 cents per bushel over contract price. The whole purpose of this discussion is to show some of the many variations available to the creative trader. Lastly you have to look at available stocks of the individual commodities. If we have a small harvest of Hard Red Winter wheat but heavy stock levels the price will not rise as high as the contract that we have a trend line production number coupled with diminishing stocks. Another discussion for delivery is the current location of the stored wheat. Delivery to the gulf is preferable to lakes delivery explaining the massive pileup of Soft Red Wheat in Toledo, OH.

To better acclimate yourself to the ranges in these spreads you have to look at long-term historicals. Historically any time Kansas City was priced under Chicago you would see commercial interests buy Kansas City while selling Chicago looking for the spread to return to a normal level between 32-48 premium over Chicago. A historical range between Minnesota and Chicago is 33-47 based on the mean of a 5-year weekly average range and clearly shows a propensity for Minneapolis wheat to bounce as the two markets approach par value with an extreme high at 154 seen last year. The historical range between Kansas City and Minneapolis is not as delineated as either individual versus Chicago. The historical range between the two is Minneapolis 5 ½-cents under to 10 ½-cents over. Thus, a lack of traditional spreading between the two exchanges. The volatility is simply too high in this spread for many to venture in. The only time to look at this spread is at an extreme. If Minneapolis reaches 50 over KC generally selling Minneapolis is a good bet.

The independent growing areas for these three crops offers an opportunity by taking advantage of drought, overt wetness, wind damage, planting and harvest problems in one contract while the other two contracts react to differing or completely different market inputs. For example, weather over Oklahoma may be perfect offering little to no bullish momentum for  the Hard Red Winter contract while areas in North Dakota and Minnesota may be beset by drought and crop stress offering upside momentum to the Dark Red Spring crop. This offers a chance to buy Minnesota while selling Kansas City looking for production problems in Minnesota to help price prospects of the Dark Red Spring wheat contract while the Kansas City contract lacks this bullish input. This cannot happen in either corn or beans due to the standard contract. The difference in growing regions and specifications offers this opportunity to wheat alone. This situation can be reversed in any manner including one of the three contracts. If international demand for Hard Red Winter wheat is seen to increase over the next year a trader should look to go long the Kansas City contract while selling either the Minneapolis or Chicago contract. If Soft red wheat starts to move out of Toledo, OH, look to go long the Chicago contract while selling either Kansas City or Minneapolis.

The downside to wheat intermarket spreading is an overall lack of liquidity in the Minneapolis contract and to a lesser degree the Kansas City contract. This is an issue for all participants who wish to enter these markets with size positions. This problem is exasperated in deferred contracts where liquidity is a fraction of the front month. Both Kansas City and Minneapolis have remained on the sideline of the recent influx of fund money and participation seen in Chicago. There has been interest in both exchanges but to a much smaller extent than seen in Chicago.  The second risk factor is the added fundamental variables when you combine the fates of two different commodities. Even though wheat is one commodity in concept one has to look at each individual exchange as having its own individual commodity. Simply put; every intermarket spread a trader enters doubles the number of inputs you need to manage to help ensure a successful trade. In so much, this is not a recommendation for those looking to scalp a market or for traders who wish to enter and exit markets quickly. This model of trading is for those traders interested in long-term trend style moves.

The benefits of this trade are first, more options to enter the market and second, variability within the same crop year. The first is self-explanatory. The more markets you are looking at, the more opportunities that are bound to develop. There is no need to limit your scope to just spreading between Chicago commodities. In a market more and more dictated by money flow and non-traditional trading, the classic fundamental differences are there to exploit for an educated, creative trader. Take a look at the traditional difference between beans and either the Minneapolis or Kansas City contracts. Take a look at corn versus these two contracts. The variability within wheat offers three separate methods to enter one market. There is no other agricultural market offering similar opportunities.

Matthew M. Pierce has been in the commodities business since 1998 working in both the cash markets and futures markets with ConAgra, Cargill Investor Services, Goldman Sachs and is a new addition to Walsh Trading team. As a member of the CBOT, Matthew acts as a dedicated broker for Walsh trading offering the unique option of direct in pit contact for their clients. Matthew offers order execution and brokerage of both options and futures contracts while informing clients as to market movement, market participants and directional market factors throughout the session. Matthew is also an analyst offering Walsh clients’ daily write-ups on both fundamental and technical perspectives affecting all CBOT agricultural markets.

Are you listening? You should be!

Walsh Trading is pleased to announce the Walsh Trade Voice (WTV) 2007 Cornbelt Snapshot Tour report has begun. With quality first hand information you cannot get anywhere else, the Cornbelt Snapshot can be heard live at 7:35 AM, CST on WTV and in its recorded version once the live broadcast is completed. The 2007 Cornbelt Snapshot Tour features input from 8 diverse locations throughout the entire U.S. Cornbelt. Listen now!