Arbitrages and Anomalies in the KC Wheat Basis ?

Grain traders are the experts at optimizing the logistics from the farm to markets. Their main role is to identify discrepancies and then re-balance markets.

They are looking to convert risks (when it can be managed) into an opportunity.

The basis captures the effects of local supply and demand, and factors the transportation costs as well. It is the delta between the spot and the futures prices and is it read by the grain traders to spot the discrepancies.

CASH HRW-KC CME Wheat Futures

wheat-basis

Credit: agmanager.info

The first observation pertaining to the KC HRW basis 2016/17 is a deep parallel shift in the negative territory.

The second observation is that a sharp V drop of the basis coincided with the expiration of the last 3 KC Futures contracts (circled in red).

-Commercial-wise, GC demand is lower than 2015 and grain is bidding from space.

-Conceptually, it is sub-optimal to finance wheat hedges and lock in carry (c) is < than the net interest rate, storage, yield for the delivery term. In other words,  when the carrying costs incurred by ABCDs for storing a crop is less than the flat storage charge, they won’t accumulate more than 30-60 days of inventory on hand and prioritize the resources for a trade with more time value – say the soybeans shipping orders.

In Kansas City, futures have 5X more liquidity than the cash market. The Longs don’t take delivery (seemingly) combined with the previous observation create this lack of price convergence between the cash and the futures at the expiration. Ultimately, it’s prices or the USD dollar that have to get lower to change the price dynamics in hard red wheat.

FARMERS VS GRAIN ELEVATOR’S BALANCE SHEETS

ABCDs buy grain, hedge it and look for opportunities to sell it in the time-space. Jacques (2016).

Large crops are usually good for grain elevators’ balance sheets.

A -$55/MT discount ensures that somewhere, someone will find some ways to move that crop in time and space and solve the current deadlock in the wheat market.

ARBITRAGES

“Conceptually, traders arbitrage price differences until markets have equal basis adjusted for shipping costs. In fact, location arbitrage is a “trading strategy to profit from market inefficiencies in price differences” (Simon 2015)”.

RISK-ARBITRAGE

An arbitrage that contains an element of risk *.

The physical, the paper markets-or the risks that they entail, and finance are the three pillars of this commodity trade.

Low crop prices will continue to pressure farmers’ balance sheets. 

Economically, the significant drop in crop prices over the law few years has made it a very challenging time on the farm, as in many cases current prices are below the cost of production. Lenders are closely monitoring the situation.

The structure in farm lending is ABL. Giving the strength of the farmland value, I fully expect that banks will advise farmers to sell some land, cashing-out equity gains to cover negative CFs from the operations.

The cycle is not expanding. We’ll see in 2017 the rising importance of documenting counterparty default risk* as well as a market not necessarily compensated for its credit risk*.

Wishing you a lot of success in your trades and projects in 2017 !

Simon Jacques +1-226-348-5610

Commodity trading and finance.

Advising the producer, processor and end-user in North America.

 

Keywords: Soybeans, Cargill, arbitrages, Financing, Wheat, HRW, KC wheat, grain markets

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