“Common Sense” Trading Decisions

“Everybody gets so much information all day long that they lose their common sense.”

— Gertrude Stein, author

Information overload plagues most of us these days. Blackberries and cell phones feed us text messages whether we want them or not. Global news is available instantly to anyone with an Internet connection. Powerful, cheap computers let anyone develop in-depth analyses and graphics from online databases. (Psst… Want to know the trendline growth of China’s hog population? Check USDA’s website.)

Modern technology is terrific. I use it daily, spend a lot of time at USDA’s databases and have constructed more charts and PowerPoints than I can count. But sometimes we have to stop gathering and analyzing and use a little common sense (“CS”) when making grain merchandising and pricing decisions. What goes up can go down; what can’t change — may change. Two areas come to mind where some CS may serve us well right now:

• Grain quality

• Futures spreads

Corn and wheat quality continue to plague many areas of the country. A significant amount of remaining 2009 western hard red wheat is low protein and has apparently been tucked away to blend with new-crop. A lot of ’09 soft red wheat stocks contains vomitoxin, reducing the value and limiting the potential markets. The 2009 corn crop in many areas suffers from low test weight, mycotoxins, high moisture, or worse. Quality problems have forced merchandisers and managers to confront tough choices.

Wide futures carries will pay the costs of holding poor-quality grain into the 2010 crop year to capture blending opportunities and/or the potential for reduced discounts, and higher overall revenue. Some merchandisers have focused heavily on futures spreads, setting objectives to capture as high a carry as possible.

Kansas City wheat futures carries have been trading recently at 90% to 97% of “full carry,” the theoretical maximum monthly futures carry (excl fees/commissions). Merchandisers see that KC wheat has been paying almost 6/bushel carry per month, well above a country elevator’s interest cost (around 2/month). That extra 4 is a nice monthly return for space. Add in any potential for blending better new-crop wheat with lesser-quality old wheat and filling elevators with company-owned hard-red wheat looks like a great deal. It may well be, but there’s a lot of wheat out there and spring/summer basis has fallen to extremely weak levels. Buyers aren’t sure what the quality of 10 wheat will be and can’t sell/export low-quality wheat. This has left a number of elevators long the basis with declining nearby basis values and no profitable way to liquidate.

The new CME Variable Storage Rate program on soft red wheat provides a way that wheat monthly futures storage charges can change with each delivery cycle, depending on certain market parameters. (See October 2009 issue, “Wheat, The Road to Convergence.”) With a surplus of wheat here and abroad, the futures market has anticipated that the VSR will expand to its maximum storage rate and spreads are already pricing in a lot of that potential. July 2010/July 2011 CBT wheat is trading around $1.05 carry (8 3/4/month), far above the old “full carry” of about 73, but still below the new theoretical maximum VSR carry of about $1.73/bushel. That $1.73 for 12 months would pay 14.4/month to an elevator! Little wonder country elevators are raising their basis for summer 2010; they want to own wheat and earn storage revenue to hold wheat that exporters and mills don’t want! The projection is made easier with spread charts and analyses that can quickly map out just what each spread is paying. (See chart.)