Posted by: usset001 | November 4, 2010

Thoughts on the Hard Red Spring Wheat basis

Crookston, MN March HRS Basis

In the grain trade, cash prices are typically quoted as a “basis” of so many cents “under” or “over” the futures price. Basis is the difference between a cash price at a specific location and the price of a particular futures market. When basis is quoted, it is normally the nearby basis, or the cash price less the nearby futures price.

When considering the tone of grain markets, I like to focus on basis because…

(1)    I think like a hedger. Hedging positions with futures contracts is the norm in the grain industry. Hedging, by definition, is to buy or sell a futures contract as a temporary substitute for an intended later transaction in the cash market. If every cash grain position you had was offset by a futures position, would you care if wheat prices increased or decreased by $1 per bushel? No. What would you care about? How about the relative increase or decrease of your offsetting positions (e.g. the cash price increased $1 but your offsetting futures position only increased 85 cents). That’s basis, and that’s why hedgers are more concerned with basis than flat prices in their trading activities.

(2)    Basis reveals more about local market conditions than the futures market. Basis is the link between the general price level (i.e. the futures market) and the cash price at a specific location. Local prices – and basis – speak to the general price level and local economic conditions such as transportation costs and availability, local supply and demand, and local storage conditions. I like to say that “futures are global, cash prices and basis are local”.

(3)    I am a lousy predictor of prices, but I am not half-bad in predicting basis. Countless factors affect the general price level of commodities – cash and futures prices are very difficult to forecast. Basis is more predictable because cash and futures prices are related by the delivery terms of the futures contract, and they should converge in the delivery month (I used to say “must converge” but convergence problems are a different topic for discussion).

So now that you understand why I am hung up on basis, let’s talk about the basis for hard red spring wheat in the Red River Valley (and I will not refer to it as the “Red River Valley of the North” – I think Texans should refer to theirs as the “Red River Valley of the South”). I have a long series of data for cash wheat prices and basis (all quotes reflect 14% protein) from Crookston, MN, about 25 miles east of Grand Forks and smack dab in the middle of the Red River Valley. Here’s what I can tell you about the basis in Crookston.

  1. Since 1990, the spring wheat basis at harvest (the 3rd week of August) has averaged 30 cents under the September contract. However, it appears to be getting weaker since 2007, as wheat prices found higher levels (69, 56 and 36 cents under in 2007, 2008, and 2009 respectively).
  2. This year (in August 2010) Crookston recorded the weakest harvest basis on record; 90 cents under the September contract. A basis of 100-120 cents under was all too common in many parts of eastern North Dakota during August and September this year.
  3. Combine a weak nearby basis with a decent sized carrying charge from September to March futures, and you have the widest March basis at harvest – 125 cents under. My records show no other years when the harvest basis exceeded 100 cents under the March (2007 and 2008 showed brief periods of 90+ under). (I like to look at the basis relative to deferred futures in order to get a bigger picture of carrying charges and storage opportunities. Looking at the March contract in Minneapolis might strike you as an odd choice for a deferred reference point – it is the May contract that is the last pure “old crop” contract in spring wheat. But the May contract is heavily influenced by happenings in the world of winter wheat. I’ll stick with March for my big picture look.)
  4. The March basis becomes the nearby basis in early December, and the March basis has room to strengthen much more in the next four months. It’s already strengthened significantly: that 125 cents under the March at harvest is now 50 cents better, or about 75 under today. I think it has another 50 cents (or more) to go before the end of February.

How about some examples of a strong basis from the last 10 years? Since 2000, The March basis has found a way to go to even money (a zero basis) to positive (cash prices over March futures) in 8 of 10 years during the November to February period. Some of these years are modest positives (0 to 5 cents over), but positive nonetheless.

If you have unpriced wheat in storage, selling the carry remains a great opportunity. MGEX March futures are close to the $8 mark. I am making the bold prediction the selling the carry will lock in a cash wheat price of $7.75 per bushel by February (or 25 cents under the March). That’s 30-40 cents better than the current bids on forward contracts.

Will we reach $8 cash wheat in the next few months? I am a lousy predictor of prices. Can we reach a basis of 25 cents under the March next year? I do better when predicting basis.

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