Posted by: usset001 | October 8, 2008

An illustration of “large” carrying charges

This morning I received an interesting inquiry about recent trends in carrying charges. A colleague wrote, “I have been watching the carry in the corn market.  With a big price decrease I would usually expect an increase in carry [i.e., a widening of the premium from the nearby to deferred futures contracts] — not this time.  It [the Dec’08 to Jul’09 corn spread] has dropped from 42 to 39 cents.” 

My colleague is correct. Normally, spreads widen (carrying charges become more positive) when grain prices decline. This tendency is what defines a “bear spread,” or selling the nearby and buying deferred futures contracts when we believe futures prices will trade lower.

This particular example is an excellent opportunity to test my new way of assessing “large” carrying charges (see my post dated September 29). The December-July futures spread maxed out at 44 cents in early August, and closed last night (10/7/08) at 39.25 cents. Did carrying charges actually get smaller? Let’s apply my new way of assessing carrying charges to the situation…

August 1

Carry/month = 44 cents/7 months = 6.3 cents/mo.

Monthly interest cost = $5.20 cash price * 6% interest/12 months = 2.6 cents/mo.

Carry/Interest = 6.3/2.6 = 242%

October 7

Carry/month = 39.25 cents/7 mo = 5.6 cents/mo.

Monthly interest cost = $3.70 cash price * 6% interest/12 months = 1.85 cents/mo.

Carry/Interest = 5.6/1.85 = 300% 

When we measure the size of the carry relative to interest costs in financing stored grain, we learn that the carry has widened! This new way of assessing the size of the carry is not nearly as simple as the old way, but it is much more accurate.

I have measured carrying charges in this manner every year since 1989. I use the Dec/July carry and cash prices as of mid-October and compare it to the cost of financing corn held in storage, using prime plus 1% for an interest rate. Only 4 years (1999, 2001, 2004 and 2005) have I measured a carrying charge greater than 300% of interest costs, such as we see today. Corn is a large crop and large carrying charges at harvest are the norm, but the average since 1989 is a Dec/July carry closer to 220% of the interest cost.


Responses

  1. Very good info.


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