- Futures spreads show us the real supply and demand situation of any market. That point is not up for debate.
- In the case of Chicago SRW wheat, the September-December futures spread has been so bearish over the past month the CME's maximum commercial storage rate will be triggered.
- I disagreed with the idea of the CME's Variable Storage Rate idea back when it was first proposed more than a decade ago, and believe it or not my opinion hasn't changed.
This week in the grain and oilseed sector the major topic of discussion has been market supply and demand, how we differentiate between what’s real and what’s imaginary. I’ve talked about the use of basis and futures spreads as our reads to understanding the real world, and at this point if this isn’t the generally accepted view then there are some things I simply can’t fix. If you still believe the best view of supply and demand comes from USDA, NASS, media opportunity crop tours, etc., then I’ve got a mountain villa in south central Kansas to sell you. The fact futures spreads show us commercial positioning is beyond debate, so I won’t be doing it anymore. I don’t have enough time left on this planet to be wasting so much of it.
Given futures spreads tell us not only commercial positioning but their short-term and long-term view as well, the spotlight has been burning bright on Chicago (SRW) wheat the past month. Fundamentally the market has been, is, and will continue to be incredibly bearish for the foreseeable future. Again, I do not care about the “Yeah but, the Black Sea!” argument. I know what I see in Chicago wheat futures spreads, and I have been tracking what the CME is set to do in response. The CME has this program called a Variable Storage Rate (VSR), and every so often the market goes through an averaging period where if the nearby spread is above X percent full carry then the commercial storage rate increases to the maximum rate.
In the case of Chicago wheat, the averaging time period has been from July 19 through the close of business today, August 25. According to the rules laid out at the bottom of the CME’s table, “If the Running Average Percent of Full Carry on 8/25/2023 is 80% or greater, the Maximum Premium (Storage) Charge will increase to $0.00265/bushel/day on 9/19/2023”. For the record, the maximum storage charge is at $0.00165/bushel/day. In other words, the maximum storage rate would go to roughly 8 cents/bushel/month versus the current roughly 5 cents/bushel/month.
As we can see on the attached table, the September-December futures spread has been running close to 100% of full carry (storage plus interest) since the beginning of August. This has raised the running average percent of full carry to 89.6% at Thursday’s close (red box), sealing the fate of VSR come September 19. The only question now is if the running average is greater than 90% when the dust settles on Friday’s session. It doesn’t change anything, but just think about incredibly bearish supply and demand has to be for that to happen. And if that weren’t enough, the December-March spread closed Thursday at a carry of 26.25 cents and covering 97% calculated full commercial carry (cfcc). For the record, the Barchart National SRW Wheat Basis Index (ZWBAUS.CM) was calculated at 68.75 cents under September futures Thursday with theoretical basis versus December at 98.25 cents under. That’s right, nearly $1.00 under futures.
All this brings to mind the situation when the CME first proposed VSR back in 2008, if I recall. At that time, futures were surging as a result of unchecked noncommercial buying that collapsed both the basis market and futures spreads. The latter were covering well above 100% full carry and nobody was moving grain. Again if memory serves me, basis was in unchartered territory with the $2.00 under number sticking in my head (if you remember it as worse than that, please let me know). I recall it was a major point of discussion at farm shows the next couple years.
To combat this fundamental problem, the CME came up with the idea of increasing storage rates to get cash grain moving again. Believe it or not, I argued against the move at the time, but it went ahead anyway. My argument was the CME’s plan was nothing more than putting lipstick on a pig, that it didn’t change how bearish the fundamentals of the market were only that it didn’t look as bearish. Consider that same Dec-March spread today. Thursday’s close, with the current storage rate, had the spread covering 97% cfcc. At the increased maximum rate the spread would cover 73% cfcc. While still a bearish read on supply and demand, according to my scale where the threshold is 67% or greater, commercial traders will still see the opportunity to hedge and hold.
In my mind (as scary a place as that is), it was and continues to be better to allow the market to wash itself out. If US producers see futures spreads running at more than 100% and basis collapsing, fewer acres will be planted and less of the crop produced. As I wrote at the time, sometimes a market needs an enema. Given this, the old adage of “low prices cure low prices” will eventually work things out. But the US is not about allowing markets to figure things out on its own, presumably, otherwise why would there still be monthly attempts at manipulation? But I digress.
The other argument made for VSR is storage rates should be higher to begin with, that the 5 cents/bushel/month is too low. That I can see. But if that’s the case, why make the higher rate variable? If you want to keep grain flowing through the system make the higher rate permanent. This would allow for market forces to account for storage and interest fees and continue to work supply and demand out on its own. Again though, that is a discussion for another day.
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
