Tag Archives: wheat

Commitments of Traders Data Suggests Wheat Bottom not yet Formed

As many of you know, our our primary focus is the analysis of the Commodity Futures Trading Commission’s (CFTC) weekly Commitments of Traders (COT) report. More specifically, our analysis lies in finding and quantifying unsustainable position imbalances among the trader groups. In the past, we’ve measured this against both historical levels and recent changes in actions in order to quantify both market sentiment and market capacity among the different trading groups. Today, we’ll provide Equites.com’s readers with a first look into our new method of calculation. Why we changed and what it’s current telling us about the Chicago wheat market.

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Commercial Buyers See Wheat’s Value

We often state that commercial traders are value players. They take action in the futures markets when there’s alpha to be gained over and above their local cash offerings. The only real difference is whether we’re discussing wheat growers hedging their forward production or, whether discussing the long hedging end users in the wheat market. Both of these participants are responsible for meaningful price discovery in the futures markets through their actions. However, their actions and their corresponding effects on the underlying market couldn’t be more different quantitatively or, qualitatively. We’ll examine the current situation and setup in the chart below.

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2015 El Nino and the U.S. Grain Markets

The National Oceanic and Atmospheric Administration (NOAA) has repeatedly stated the growing case for the 2015-2016 El Nino event. While much has been discussed in the headlines, very little of the conversation has focused on the commodity price impact that the most significant El Nino weather pattern since 1997 could have on U.S. crops. This week, we’ll begin our look at how the U.S. grain markets performed during 1997-1998 El Nino and continue this line of thought through the global grain markets next week before finishing this segment with a look at El Nino’s impact on energy prices.

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Commercial Traders Support Wheat’s Seasonal Bottom

The Chicago Board of Trade soft red wheat contract has declined by nearly one third since the early May high near $7.50 per bushel in the current September contract. The mild summer has brought with it the classic seasonal May-July sell-off. We believe that this market may be ripe for a bounce based on demographic, seasonal and technical factors.

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Historical Wheat vs Corn Spread Prices

Trading the grain markets has always been tricky, especially during the planting and harvesting periods. Historically, this has placed us at the agricultural epicenter for global grain trade. Obviously, tension in Ukraine and the corresponding 15% spike in wheat prices have reminded everyone that even the agricultural markets are now a global game. In this respect, it’s no longer enough to keep an eye on domestic weather patterns to determine the success of our winter crops or anticipate spring wheat seeding. Now, it is imperative to focus on global production issues and World Trade Organization (WTO) agreements, as well.

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Trading Ukraine Uncertainty

Removing the politics of the Russia-Ukraine issue and focusing on the economic implications of Russia’s bloodless annexation of the Crimean peninsula puts some trading opportunities on the table as global risk premiums jump. In order to do this, a couple of suppositions must be declared. First and most importantly, the United States will not actively engage Russian troops. In many ways, this is a replay of the Georgian conflict in 2008. Georgia was in revolt against Russia and wanted closer ties to the European Union and the US. Their cause was quickly championed by Western leaders until it became obvious that neither the European Union, The United States nor, NATO would take any military action to defend Georgia against Russia. This episode set the precedent for the current situation.

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Wheat May Have Bottomed Out

The wheat market is a primary staple in human diets as well as global trade. This causes the wheat trade to be affected nearly as much by geopolitics as it is by price and weather. Therefore global trade prices have to factor in sanctions, duties and taxes as well as transportation fees. The simplest way to understand this is by looking at the surplus produced by the primary growers like Canada, Ukraine, Russia, Australia, Argentina and the European Union as well as us and then trying to determine why each one of those countries are also wheat importers. Due to the conflagrated nature of global trade negotiations, I find it easier to focus on the primary players here in the U.S. and plan my trades accordingly.

First, I screen the markets’ traders and their eagerness to participate in any market by reviewing the Commodity Futures Trading Commission’s weekly Commitment of Traders Report. This report breaks the markets’ participants into a few primary categories – index traders, non-commercial traders, commercial traders and non-reportable. Briefly, Index traders manage the long only allocation portion of the fund they represent. Non-Commercial traders tend to be the money managers within the futures industry. They trade from both the long and short side as they see fit. Commercial traders are either the producers of the commodity or, the end line users of it. Their trading is based on managing their costs from the production side and maximizing their profits on the producer side. Finally, the non-reportable category is left to small speculators, producers and end line users who are too small to qualify for a larger group.

Hedge funds fall into the non-commercial trader category and their movement finally began to be tracked by the CFTC in 2006. The last three weeks has seen the largest jump in their short position since their trading has become a matter of public record. There are three important factors at work here. First of all, most of this selling took place prior to the November 8th USDA crop report. Secondly, commercial traders in this case, the end users, have absorbed every bit of selling the speculative money has thrown at them. Finally, this dynamic shift in market participant makeup comes near major support near $6.50 per bushel in the March Chicago Board of Trade contract.

This sets the stage for a climax. Our bet is that most of the price decline has passed. Commercial traders are value players. We are looking at the end line wheat consumers locking future delivery prices in order to generate their business models for 2014. Cereal and bread producers are fully aware of what their input costs are and they clearly view this as a bargain. The non-commercial traders who’ve taken the short side of this market are typically trend followers and pay little attention to price. They’re simply riding the wave….until it crashes.

I believe their wave is about to crash. First of all, wheat hasn’t been this cheap since July of 2010. Secondly, in both June of 2010 and May of 2012 commercial and non-commercial traders squared off in a similar manner. These market imbalances strongly favor an outcome in favor of the commercial traders. In fact, most solid wheat rallies start by commercial traders putting a floor in to support prices and lock up future inputs. Conversely, every trend trader trades the trend until it’s over then, they give back a chunk of their profits on the ensuing market turnaround. Finally, open interest peaked in September and has begun a much earlier decline than normal into the December futures expiration cycle. This means the market is failing to attract new players at these depressed levels.

The daily chart shows a solid basing pattern that is holding just above major support. The December wheat futures rapidly approaching expiration means that anyone who doesn’t intend on delivering wheat of the appropriate standard to an approved collection site as well as those who aren’t fully prepared to take delivery of the contracts they’ve purchased must offset their position. Obviously, end line consumers are looking forward to their delivery of cheap wheat. Meanwhile, none of the non-commercial speculative money will be able to make any deliveries. Therefore, I believe that the buying from non-commercial short covering will begin to fuel a rally in the wheat futures market.

You can find more on our application of this strategy at COTSignals.com.

Winter Wheat Drought

The summer is over but drought fears continue to haunt the grain markets. The rain we never received this summer has turned into snow that we hope is coming. The corn and beans have long since been harvested but the U.S. winter wheat crop is the next grain market to be left high and dry while European wheat is left to drown in its own wealth of precipitation.

The USDA Crop Progress Report showed 39% of the U.S. winter wheat crop in good or, excellent condition as of November 4th. Sounds pretty good, right? The reality is that this is the lowest, “good to excellent” rating for this time of year in the 27 years that this report has been issued. The U.S. Drought Monitor still shows drought across more than 62% of the nation. More importantly, the, “extreme drought” area still covers approximately 6% of the nation. This includes major growing areas like Nebraska and is expanding through the upper Midwest and Great Plains.

Meanwhile, across the pond, planting in France and England is well behind schedule with France’s plantings 24% behind last year’s pace. Further adding to the globally bullish tone is Russia’s recent reduction of this year’s harvest by half a million metric tons, which drops it to a 9 year low. These forces have reduced the global stocks to usage ratio, how much we have on hand relative to what we’ll need, to 25.4%, which is the lowest level seen since the 1970’s according to the USDA.

The tightness in the wheat market can be seen in its performance relative to corn and soybeans. Both corn and soybeans have pulled back considerably from the highs they made this summer. Corn is currently more than 12% off its August high and soybeans have pulled back by more than 14% from their September high. Wheat on the other hand is less than 6.5% off of the July high and has merely drifted lower following its peak.

The technical name for the chart pattern that wheat has created since its high is called a, “bull flag.” The reason for the name is when looking at the chart it resembles a flag fluttering in the breeze at the top of a flagpole. The wheat market began a vicious rally in late June, climbing more than 50% in five weeks. This rally can clearly be viewed as the flagpole. The market’s meandering since the highs have been confined to a range of 11.5%. This range marks the boundaries for the flag. Finally, as the volatility has died down, the trading ranges have become smaller and smaller. This consolidation is illustrative as the flag forms the tip of its pennant.

The market’s quiet period of consolidation also leads to the eventual eruption once the trading boundaries are violated. The expected breakout will give clear direction to the market’s participants that it is no longer in a trading range and higher prices lie waiting ahead. The target of the bull flag formation can only be determined once the breakout occurs. The simple measurement is the addition of the consolidation distance between the breakout point and the lower boundary of the flag to the breakout point itself. This is a 1:1 trade since the expected risk, without managing the position, is equal to the profit at the trade’s target price.

The primary trend in the near future will certainly be higher. However, I’d like to add a note of caution to trading the wheat markets. Dennis Gartman always uses the line, “Wheat is a weed and will grow as such.” There have been several instances where a poor wheat crop has made a substantial recovery. These recuperative powers are best viewed quantitatively through the actions of commercial traders. These are the people whose livelihood depends on proper analysis of their market. Mechanically speaking, one of the best trades is to wait for commercial traders to call a top in the wheat market. This can be seen in the Commodity Futures Trading Commission’s “Commitment of Traders” report. When the commercial traders start selling, we want to be with them. Trading a commercial sell signal has generated nearly $2.50 for every $1 risked while only being in the market for 5 days. Investors will profit from being long wheat. Traders will profit doubly as they ride the tight supplies higher and catch the fall from the peak, as well.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Wheat and Corn Spread at 25 Year Highs

There are prices we accept in life as absolutes. We accept
that gold is more expensive than silver or that a Mercedes is more than a
Chevrolet. Sometimes, things change. Remember when diesel fuel was cheaper than
gasoline? Not only is diesel more expensive, it has maintained its premium for
more than ten years now. Recently, another market relationship has been called
into question – the relationship between corn and wheat.

Historically, wheat futures trade at a premium to corn
futures. In fact, over the last 40 years, there are only about ten periods
where corn closed at a higher price than wheat. Going through 15,000 days worth
of data, I found that there were a total of 56 trading sessions that corn
closed at a higher price than wheat. This is .0037% of the time. Nineteen of
these closes have occurred this year and fifteen came in 1984. There have been
no instances of this for more than 25 years.

The typical eyeball range for the spread is around $1.50.
Wheat is normally worth about $1.50 more per bushel than corn. The widest this
spread has been is $7.15 in March of 2008. The recent peak was in August of
last year at $3.82. Conversely, when this spread has gone the other way, as it
is currently sitting, the widest we’ve seen it was corn trading $.40 cents over
wheat last month.

I went back through the USDA Acreage and Crop Production
reports from the periods when this spread went negative and found some
similarities between 1984 and 2011. The carry out stocks for the new crop years
were exceptionally tight in both cases. The carry out stocks at the end of the
1983 crop year were lower due to two factors. First of all, fewer acres were
planted in 1983 due to governmentally implemented acreage reduction programs
following record production in 1982. Secondly, crops in 1984 experienced severe
drought conditions, which led to the second smallest harvest in history. In
fact, the 1984 harvest ended up being 49% lower than 1983’s.

We started 2011 back at the same record low stocks to usage
ratio we were at 25 years ago. This year, the governmentally sponsored ethanol
production intends to take 40% of the 2011 crop off of the market and we have
had lousy planting weather on top of that. Combining governmentally driven
demand and lousy weather we begin to see the similarities between the 1984 and
2011 crop years.

The corn and wheat contracts for September delivery are still
trading back and forth of even money. The trading idea is to sell corn at a
higher price than we buy wheat. This strategy will profit as these two markets
return to a more normal trading relationship and wheat begins to rebuild its
premium over corn. This spread has recently traded as far as $.33 cents towards
corn over wheat at the end of June. The highest it has been is $.40.

Calculating the trade on a cash basis, we can determine our
trading parameters. Forty cents is equal to $2,000 per spread position in risk
to a trading account’s value. Conversely, a quick reversion to the spread’s
normal range of $1.00 to $1.50 in wheat over corn would equal a cash value of
$5,000 to $7,500 in trading account profits per spread position. However, as
with the diesel fuel to regular unleaded example, it’s possible that these
market relationships can shift from anomaly to a new normal. Therefore, risk
must always be the first consideration when deciding whether or not a trade is
suitable for your account.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.