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For many grain producers, opinions about price level and direction are front and center in marketing decisions. Prices are important, but I think that carrying charges tell us
more about the bullish or bearish tone of a market. Carrying charges should have a higher priority in our pricing decisions than the bulls and bears who argue about whether or not it is going to rain in the Corn
Belt this weekend.
Carrying charges are the price differences between futures delivery months (e.g., September and December wheat
futures). Positive carrying charges (aka large carrying charges) - deferred futures contracts trading at a premium to nearby contracts - are common when free supplies of grain are large. Large grain supplies result
from a bumper crop and/or poor demand, and point to bear markets and lower prices.
Negative carrying charges (aka inverted markets) - nearby futures contracts trading at a premium to deferred
contracts – occur when supplies are scarce. Scarce grain supplies result from a poor harvest and/or strong demand and they set the stage for bull markets and higher prices.
The accompanying chart tells the story. From early June to late July, Sep’09 futures prices declined from $8 to
under $6 per bushel – a bearish price pattern by any standard. I see the bearish tone in widening spreads; the positive carrying charge from Sep’09 to Mar’10 futures increased from 15 cents to nearly 29 cents from
early June to the end of July.
How large is “large” when measuring a carrying charge? I recommend a simple three-step process to measure the
size of a carry.
Step 1: Calculate
the carrying charge per month: If the Sep’09/Mar’10 carry is 29 cents, then the carrying charge per month is 29 cents/6 months = 4.8 cents per month. In Minneapolis, I prefer to analyze at the September/March
spread. Winter wheat markets heavily influence the May and July contracts.
Step 2: Calculate
a monthly per bushel interest cost for grain storage: With Sep’09 futures close to $6.00 per bushel, the cash price of spring wheat at harvest will be close to $5.55 in the Red River Valley. With the prime rate is
3.25%, the annual cost of financing spring wheat in storage (at 1% over prime) is $5.55/bu. * 4.25% = $0.23 per year or 2 cent per month.
Step 3: Compare
the size of the carry to your interest costs: 4.8 cents per month / 2 cent per month interest = 240%. The carry in the wheat market from Sep’09 to Mar’10 is more than two times larger than the interest costs you
will incur by holding spring wheat in storage. For perspective, I have a history of the Sep/Mar spread at harvest going back to 1989. The current measure – 240% of interest costs – is the second largest on record.
As of late July, the corn market was also sporting very large carrying charges, while the soybean market showed
positive but small carrying charges.
What strategy makes sense if carrying charges are large at harvest? The market is sending signals to store
spring wheat and sell the carry in the market with a futures sale or hedge-to-arrive in the March contract, with an eye towards lifting the hedge early in 2010. This strategy gives up your “upside” potential in
exchange for a hedge against lower prices, covering out-of-pocket storage costs, deferring income to a new tax year and giving yourself time for an improved basis.
What are carrying charges saying to you?
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