Posted by: usset001 | August 26, 2008

Carrying charges in grain markets

Harvest is in full swing in the Northern Plains and small grains, including the hard red spring wheat crop. That means we are just weeks away from the start of harvesting row crops. My mind is turning towards post-harvest marketing strategies, and these thoughts start with a look at carrying charges in the market.

Carrying charges are the price differences between futures delivery months (e.g. September and December wheat, March and July corn futures, November and May soybean futures, etc.). Carrying charges are positive when a deferred futures contract trades at a premium to the nearby contract. They are negative or inverted when a deferred contract trades at a discount to the nearby contract.

To examine the bullish or bearish tone in the market, most market watchers focus on price levels and trends. I think it is wise to place equal importance on carrying charges, both absolute levels (positive or negative) and trends over time (becoming more positive, aka “widening,” or becoming less positive or more negative, aka “narrowing”).

Large, positive carrying charges are a result of large grain supplies which, in turn, result from large crops or weak demand (or some combination of the two). Large crops and weak demand – isn’t that the formula for a bear market? Yes, and you can see how the development of a bear market and widening carrying charges go hand-in-hand.

Let me see if I can illustrate this phenomenon using the Minneapolis futures market for hard red spring wheat as an example. If you had not noticed, the past year has been a remarkable ride for wheat prices, led by HRS and durum wheat prices. March’08 spring wheat futures topped out at $24 per bushel on February 25. On the same day, new crop Sep’08 and Dec’08 futures closed at $12.15 and $11.99, respectively, or a 16 cent inverse. An inverse like that is not common, particularly in the first two months of a new crop year, but the market was showing concern over shrinking wheat supplies.

Let’s jump ahead to August 26. In the past six months, we’ve learned that the world will deliver a record wheat crop and early reports indicate a good spring wheat crop. Sep’08 futures closed at $8.96, more than $3 below the market of just 6 months ago. Dec’08 futures are also off sharply, trading at $9.10 per bushel. Market prices are off 25% but equally telling is the change in carrying charges: a 16 cent inverse in late February is now a 14 cent positive carry in late August.

Similar changes occured in the corn and soybean markets. Carrying charges have shifted from negative to positive, indicating larger supplies and, for the moment at least, a taming of the bull. Carrying charges will be foremost in my mind when I make that important decision after harvest “to store, or not to store.”

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