Watch an Inverted Carry in Corn

In grain markets, the futures spreads are a reflection of what the market is willing to pay to carry grain.

The purpose of carry markets is to allow users to structure long-term sales at/or around cost-of-carry and avoid  having to pay the big premium that are often built into the sale when spreads widen.

Inverted spreads indicate a demand greater than supply. Spreads continue to adjust throughout the season in response to the changing conditions in S&D.

An inverted market occurs when nearby prices trade at a premium to deferred prices.

You get the greatest inversion when there is extreme demand with little supply.

Inverse Carry

F1 ­> F2, F3, F4…

F1=nearby contract

F1, F2, F3 F4.= Futures or Frwd price and deferred months contract.

The inverse carry market is also a situation where

F1, F2, F3…< S0 e^(u-y)*t

So= current spot price
u= carry costs (cost to store, finance and insure grain for a period of time)
y= convenience yield (benefit to own a physical commodity)
t= time

When U­>Y, you have a strong incentive to sell now and buy back later grains.

The market wants that you sell your grain, it gives a negative yield to store it and sell it later.

What does a Grain Merchant with inverted carry markets ?

Inverted Carry market are the best incentive to sell grain now (even the grain you don’t physically own and plan to buy).

  • The Grain Merchant can use the inverted carry to Forward Sell Cash Grain (literary selling grain you don’t have) at t=0 and buy the grain at a lower price to deliver at t=1.
  • The Grain Merchant can also Sell & Deliver unpriced Cash Grain inventories at t=0 and purchase cash grain at t=1.

Best time:  early in the season when the spread begins trading, spreads aren’t yet trade, there isn’t as much activity in the deferred months which can keep the spreads relatively flat or during a rally where the nearby futures move up at a faster pace than the deferred futures causing the spread to flatten or invert.

 Market Structure

Extreme inverse carry in Corn

Extreme inverse carry in Corn

What you can see is a great inversion followed by a small carry for the rest of the 2013 season.

Spreads

The Redline is a 5 yr seasonal trend.

Watch CZ-CN.

But also watch risk, since inverted carry market are dictated by demand, nothing can stop the inverse carry could to go suddenly lower like during in JUL 2012 (inverse carry markets have no floor because they are driven by crazy corn demand). Inverse carries are somehow very difficult to trade for the professional grain trader. The trend is still there but look at -35 cents in a matter of days during the Middle of JUL 2012.

CZ-CU 2013

Wait to see if CU will be trading like an old or a new crop. (Old crop in this case would mean that Sep will still be trade at an inverse carry with Dec).

Right now CU is flattening like an old crop relative to CZ (going lower faster).

BASIS, SPREADS AND INVERTED CARRY

  • When the spread widens

When spreads widens prior harvest it is usually a sign that crops are good and there are plenty of bushels to handle. The same factors that widen spreads tend to lower the basis.

  • When the spread narrows:

Market wants the bushels sooner than rather later. The nearby month has a huge convenience yield, the basis get stronger and spreads narrow.

It is important to recognize that the characteristics of spreads in an inverse carry market structure are somewhat different from in a normal carry market structure. In a carry market there are limits to how wide carry spreads can get since the delivery process acts as a ceiling and won’t let spreads move to extremes on the carry side.

However, inversions have no such limits. Inversions are dictated by the market demand and move to virtually any level. see below

Extreme Inverse market case: 96′

I looked back in history for an exceptional year and I found it in 1996. Conclusion: Agricultural Markets are typically seasonal but the trend is not always followed with inversed carries… JUL/SEP (SEP-JUL) corn spread in 1996 has never reverted back to carry. The 96’s Old Crop name was infinity…

The story of 96

The market-making events behind the corn market boom to historic highs in the spring of 1996 were connected to China, weather, and farmers trapped by “hedges.” The bust results mostly from four favorable production years that have followed as a result of somewhat normal U.S. growing season weather.

From inverse-carry to  carry …

Grain markets are naturally and most of the time at carry markets. Farmers, Merchants and End-Users need the carry at a moment or another.

Because of the new crops, the old crop price will eventually have to collapse, and the adjustment inevitably occurred when the market has a better picture of the corn harvest (Late Jun to Mid Jul). From that point September contract should act as a new crop during (trending lower during the harvest).

In an inverted carry market Y is bigger than U; Fwrd prices are lower than spot or current futures contract but during the harvest time, a normal crop will bring back deferred futures month at carry, Y will become lower than U so F1, F2, F3…­.­­> S0 e^(u-y)*t.  The market revert to carry to the point where Carry in the forward curve can  compensate physical carrying costs of grain (storage, insurance, interest…)

New corn crop is still pricing significant premiums that will likely decay as the remainder of corn is planted.

The Trade  Shipping and Finance Wizard

 © Navigating the commodity markets with Freight and Spreads

Reading suggestions:

Boom and Bust in the ‘90s:
The Story as Told by Corn

http://portal.asfmra.org/userfiles/file/journal/stevens23_28.pdf

http://edsworld.wordpress.com/2012/05/23/the-old-cropnew-crop-inverse-in-corn-futures/

Risk disclosure: trading spreads always involve a substantial amount risk only bet what you can afford to lose (not only what you think you can lose) !

© 2013, The Trade  Shipping and Finance Wizard

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