Analysis: Spring/HRW wheat spread playing tricks on wheat traders

Minneapolis spring wheat was supposed to have regained a premium over Kansas City hard red winter wheat by now, after having slipped to a rare discount to its lesser-grade cousin at the end of September.

But instead spring wheat’s discount to HRW has widened even further, flying in the face of expectations that the end of the spring wheat harvest would lift pressure off spring wheat values while strong winter wheat crop ratings would dent Kansas City prices.

Several traders have been losing money as a result, but will be hoping that this week’s update on trader positions from the U.S. Commodity Futures Trading Commission will reveal more bullish trading patterns in spring wheat, as well as profit taking in winter wheat that will set the stage for what many view as a long overdue spread correction.

Against the grain

Since 2006, the Minneapolis December futures contract has averaged a more than 25 cents per bushel premium over Kansas City December prices due to the broadly higher level of protein contained in spring wheat which helps it command a higher price at the wholesale and retail level.

But for more than a month, Minneapolis futures have been persistently locked at a discount relative to HRW, which is the longest stretch in negative territory for that spread since 2007.

Further, the discount has actually widened lately rather than contracted to confound wheat traders who have been compiling positions designed to pay off only when spring wheat prices resurface at a premium to HRW.

A combination of price pressure from the recent spring wheat harvest coupled with sturdy export demand for HRW wheat accounted for the unusual price development to occur near the end of September, and expectations were for that discount to quickly unravel once the spring wheat harvest wrapped up and the 2013 winter wheat growing season got fully underway amid broadly crop-friendly conditions.

However, the discount has instead continued to widen, alarming traders sitting on opposing positions and raising questions about why this breakdown in traditional price relationships has managed to persist for so long.

No news is bad news

One of the chief factors likely helping to sustain the recent unusual price pattern has been the absence of trader position data reported by the CFTC.

The U.S. government shutdown brought about a cessation in the reporting of commodity positions held by various participants. These weekly Commitments of Traders reports offered a regular update on how various traders are adjusting their exposure in the various wheat classes, which can then tracked against the price movement of the markets concerned.

In the run-up to the shutdown, large speculative traders sharply increased their long exposure to the Kansas City wheat market on the back of robust export demand for that commodity during September.

Meanwhile, after having amassed their largest net short position in Minneapolis wheat futures since 2005, demonstrated only limited interest in buying back those short positions.

This divergence in trader actions impacted prices accordingly, buoying Kansas City futures and constraining any rallies in Minneapolis wheat.

But with those reports due to resume in the weeks ahead – and offer updates on how those positions have changed since late the start of October – there is a good chance that the new data will reveal some profit taking in the Kansas City market, as well as some additional short covering in Minneapolis wheat that will suggest a change in tone among the speculative community with regard those markets.

Such actions would be in keeping with the seasonal trends of non-commercial positions in those markets: Kansas City non-commercial length has routinely been reduced over the final months of the year while Minneapolis net positions have been increased.

That behavior would also be consistent with the price action seen, as although Kansas City prices maintained a premium to Minneapolis, HRW wheat encountered notable scale-up selling interest lately that snuffed out price rallies and can often be the hallmark of a wave of profit taking from the speculative community.

If upcoming CFTC reports reveal that to be the case, those traders who are short Kansas City wheat will breathe a sigh of relief, as that would indicate a decline in buying interest for that market. At the same time, the updated CFTC data will likely reveal at least a reduction in short exposure to the Minneapolis market, as there have been signs of broad-based buying in that market in recent weeks.

For those traders sitting on the wrong side of the Minneapolis/Kansas City spread, that data release can’t come soon enough, as it could just be the impetus they need to bail out of a position that has been underwater for over a month.

Gavin Maguire is a Reuters columnist. The opinions expressed are his own.

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