As the 2016/17 season draws to a close, the US wheat futures market looks unpleasantly familiar.
The Chicago Board of Trade (CBOT) nearby contract (converted to AUD/MT) is trading back at the lowly levels not seen since the start of the season.
A world lacking any substantial supply shock and a forever increasing Black Sea crop has ensured hopes of a sustained rally have been extinguished at this time.
This was despite an aggressive rally mid-season which saw CBOT Wheat Swaps rally an impressive A$45/MT in only eight trading sessions.
The market was digesting a severe drought plaguing the US Northern Plains, an extremely short fund position and capitulating US dollar.
Unfortunately, the market has given up this rally, quickly falling beyond the price trading before it began.
Amongst the volatility, the market has provided one enduring opportunity; hedging into strong carry.
When the global balance sheet becomes burdensome the market discounts pricing for prompt delivery (the nearby contract) to incentivise growers to hold grain from the market.
In return, the market pays the grower a premium to sell at a deferred date, compensating their costs of carrying grain over this period (storage and interest).
This means, instead of holding grain post-harvest hoping for a rally, growers can hedge into the carry (sell a deferred CBOT swap).
To give a simple example of this, in late November 2016 growers could sell a Dec-17 CBOT Wheat Swap at A$237/MT, $46 higher than the nearby contract.
Ten months later, the Dec-17 swap is $203/MT, and is only $8.50 over the nearby contract.
This represented a $34/MT gain on the hedge, despite a relatively unchanged spot market.
In this time, holding the physical wheat has cost around $23/MT in storage and interest, giving us a net gain of $11/MT.
So, the market has covered all carry costs and credited the grower an additional $11/MT.
To make this proposition more compelling, the grower has been able to wait for the Australian market to rise relative to the US which has eventuated, as Port Kembla ASW1 is around $40/MT higher than November last year.
As the 2017/18 harvest approaches, this opportunity will likely present itself once again.
As shown in the chart, carry premiums in deferred contracts erode over time and the prospect dissipates.
The strategy of taking advantage of carry in the futures market is well worth considering as we approach harvest.
When adopting a strategy like this, consult an expert to discuss in more depth.
