Posted by: usset001 | August 3, 2009

Carrying charges in corn

moneycornI received some interesting questions from a fellow in Texas concerning carrying charges in the corn market. I thought it might be interesting to show his questions, followed up by my response.

Question #1: Am I correct, when carrying charges are running close to full carry, do grain sales slow down, because farmers will store grain to get paid the premium from carrying charges? My response: Grain sales do not necessarily slow down when the carry is close to full, but the incentive is there to slow down. I could flip the thought around and say that the carry remains close to full because grain keeps moving.

Question #2: If corn continues to be stored due to full or close to full carry, will the cash and front month futures prices tend to rise over the distant months because of the shortage of grain coming to the market? My response: If storage continues, I would expect the basis (and not a narrowing carry) to do the work to pull stocks out of storage.

Question #3: Do full carrying charges tend to last long before they return to something less than 2/3 to full carry? My response: The worst of all answers; it depends. We must keep in mind that carrying charges can be thought of as market determined storage costs. The narrowing will occur when the market perceives lower stocks.

Question #4: Finally, is there some sort of average carrying charge for corn that tends to give some sense of normalcy? My response: “Average” and “normal” has changed over time. Three years ago I would have said that a carry in the corn market of 3 – 3.5 cents was “normal.” Prices today are much higher and the old standards are dated. I like to focus on the spread from new crop Dec corn to the following July. Three years ago or more I would have said that a carry of 20-25 cents was normal (July at a 20-25 cent premium to Dec). Tonight they closed at close to 35 cents. It costs more to store high priced grain (e.g., it costs twice as much in borrowed money to store $4 corn vs. $2 corn) and today grain prices are higher. If you must have an answer, I would estimate 4-4.5 cents per month as the new normal.

Any other info you can direct me to would be just great, as I am trying to understand how I can be a better trader by understanding the dynamics of carrying charges. My response: I have to agree with you that good information and explanations of carrying charges are scarce. The old CBOT Handbook of Futures and Options used to carry some nice textbook examples of measures used in the trade. Recent editions of the handbook have gone to a new format and don’t do a good job. Find a 20 or 30 year-old edition of the CBOT Handbook – try a used book store.

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