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
As 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
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.