Posted by: usset001 | May 11, 2010

More on carrying charges in the CBOT, KCBOT and MGEX wheat markets

I received several comments correcting me on my blog post concerning my (mis)understanding of carrying charges in the CBOT wheat market. I stand corrected and enlightened on the VSR (variable storage rate), but wide carrying charges are worth pondering in all wheat markets. I received this email just a few days ago.

I was reading a newsletter from a grain marketing firm. Check out their “percent of full-carry” on KCBOT wheat (112%) and MGEX wheat U/Z at 142%! Are these calculations right or just based on their selection of storage and interest rates?

Here’s what I have learned in the last week. First, concerning storage charges in the CBOT wheat contract, the CBOT went to “variable storage rates” in their wheat contract, beginning with the July 2010 contract (you can learn more about the VSR here). It is true that carrying charges in CBOT wheat are trading wider than full carry, but only because the market is anticipating the “VSR” will be adjusted to an even higher storage rate (reaching as high as 11 cents per month!).

Concerning KCBOT and MGEX spreads at more than 100% of full carry, I did a little of my own math. Allow me to start with the Minneapolis July/Sep spread… 

Commercial storage costs from July to September: 62 days * $.00165/day = 10.23 cents

Interest costs = $5.40/bushel * 2.25% / 12 mos = 1.02 cents/mo * 2 mos = 2.04 cents

Full carry from July to September = 12.27 cents

Minneapolis July/September SpreadAs you can see in this spread chart, the July-Sep spread has been trading in a range of 11 to 12.5 cents for much of the last 6 months (90-102% of full carry). I’ll let you explain a handful of spikes to 13-15 cents. I’m using an interest rate of 200 basis points over the 3-month LIBOR. I suppose that one could make the argument that interest costs could be higher.

Now let’s consider the Sep-Dec spread in Mpls:

Commercial storage costs from September to December: 91 days * $.00165/day = 15.01 cents

Interest costs = $5.50/bushel * 2.25% / 12 mos = 1.03 cents/mo * 3 mos = 3.09 cents

Full carry from September to December = 18.10 cents

Minneapolis Sep/Dec Spread

The nearby chart shows the Sep-Dec spread trading in a range of 17 to 18.75 cents over the past 6 months (94-104% of full carry). Again, just a small upward adjustment in the interest rate will lead to very large carrys, but carrying charges of just under 100%.

Bottom line: I cannot explain the huge % of full carry indicated by your source, but I think we can agree that the carrying charges in all wheat markets are very (very) large. It kind of has me wondering – what could a trader lose with a bull spread in the Minneapolis or Kansas City wheat markets? I know that the fundamentals are bearish, but the potential loss is limited (1-2 cents?) while the upside potential is great. Small crops and good demand happen.


Responses

  1. The main risks appear to be 1) funding problems at grain merchants and 2) rules changes at the exchanges.

    Should commercial grain traders be cut off from credit, the effective interest rates could be much higher. This is significantly mitigated by the ability of banks to participate in commodity markets–it would have to be a widespread credit crunch.

    Given that banking rules, Federal Reserve independence from Treasury, and European Union treaties are all subject to abrogation in this new world of financial crisis management, it is entirely possible that the KCBT and MGEX change their rules to match the CBOT’s new regime.

    If the NASDAQ can arbitrarily cancel 20 minutes of trading in some stocks without any accountability, then I think it’s fair to assume “anything goes” on rules.

  2. I am working toward a masters at TX A&M…one area of possible concentration is the economic time impact of carrying charges on commodity marketing.

    Your insight is very helpful in understanding grain carrying charges..

    Q. Do you know where I would find current and historical carrying charges for other commodities such as: Sugar, Coffee, Cocoa, Cotton, Crude Oil, etc.? I would be very grateful for any direction you can provide. Regards, Ron Lucas

    • Barchart.com is a great site for access to the raw data. Finding a good discussion of carrying charges in these other markets is more difficult – in fact very difficult. There are a few books out that deal with spreads (carrying charges are interdelivery spreads), but I find the background material to be light. Try talking to the exchanges and get a lead on a trader in the market – they may have a better suggestion.

  3. in minnie wheat, september is the new crop month thus N/U spread is old crop/new crop spread. carry charge calculation is meaningless.


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