The Down Escalator Simulator

There is a lot going on in the grains sector as the 2024 calendar turns from August to September.

A partial list of things that came into play at the end of August included: 

• First notice day (delivery) for the September futures contracts including:
  • September soybeans 1
  • September corn 2
  • All three September wheat futures contracts
• The end of the week, bringing to mind the Goldilocks Principle 3
• The end of the month
  • Important from a long-term investment point of view
  • The end of August was the end of Q1 for the wheat subsector
  • The end of the marketing year 4 for corn and soybean markets
• The end of meteorological summer (on Saturday, Aug. 31)
  • Putting the spotlight on what I call the “market meteorological musing 5 ” from my late friend and longtime Chicago Board of Trade floor reporter Gary Wilhelmi

That’s a long list, and I haven’t yet mentioned the subject of this piece, the “down escalator simulator.” What I mean by this is, if we watch the trends (price direction over time) of futures spreads, we see a tendency for the first deferred spread to follow the lead of the lead spread as it moves into delivery of the nearby futures contract. Why is this important? Recall Newsom’s market rule No. 2: Let the market dictate your actions. This is where our reads on real market fundamentals (supply and demand) come into play, as opposed to USDA’s imaginary version the majority of the industry gets their knickers in a twist over each month.

When I say real market fundamental reads, I mean:

• National cash indexes: National average cash prices. The intrinsic value of the individual markets. Using these gives us our available stocks-to-use figures (see my August article).
• National average basis: The differential between the national cash indexes and futures markets.
• Futures spreads: Price differences between futures contracts.
• Forward curve: Another way of showing futures spreads by plotting the price of each contract along a continuous line.

For this piece, I’m focusing on futures spreads. It’s here where the commercial side of the market (those interests involved in the trade of the underlying cash commodity) positions themselves based on their opinion of a market’s supply and demand situation being bullish, bearish or neutral. As for timeframe, spreads can indicate short-term, intermediate-term and long-term fundamental outlooks. As is the case with most elements of market analysis, one size doesn’t fit all meaning we have to take a different approach of spread analysis to the various market sectors.

When it comes to grains, since we can calculate the variables that make up the total cost of carry (storage and interest costs) over given timeframes, we can also calculate how much of that total cost of carry futures spreads are covering at any given time. The higher the percent covered, the more bearish the commercial view is of supply and demand. One of my favorite stories is of the time Urban Lehner, my former boss, took me to a meeting with the company president. The other gentleman was an economist by trade and was convinced I was wrong in my assessment that higher deferred prices in relation to nearby prices was bearish. It isn’t often one gets to prove the president of a company wrong, and not get fired for it, but that’s what happened that day.

If we look at the attached cost of carry table for Chicago soft red winter (SRW) wheat from the close of business Monday, Aug. 26, we see the September-December futures spread was showing a carry (deferred contract higher priced than the nearby issue) of 27.0 cents. The total cost of carry on that day was 33.53 cents per bushel, meaning the futures spread covered 80.5% of calculated full commercial carry (cfcc, the same as total cost of carry). Based on the simple scale I developed back in my days as a grain merchandiser, a spread covering 67% cfcc or more indicates a bearish commercial view of supply and demand. Using this scale, we see SRW wheat fundamentals were incredibly bearish as September moved toward its delivery period. At the same time, the December-March futures spread was showing a carry of 21.25 cents and covered 62% cfcc.

If we dig through the archives of the cost of carry tables, all the way back to the end of June as the July 2024 futures contracts were moving into delivery, we see the July-September spread covered nearly 84% cfcc (I’m going to focus on cfcc for now) while the September-December was covering 67% and the December-March 52%. We can see, then, how the deferred futures spreads are following the nearby futures spreads, like down escalator stairs disappearing into the great beyond below the floor.

For the record, I see the same thing in the corn and soybean futures spreads. At the same close on Monday, Aug. 26, the September-December corn futures spread covered a bearish 79% with the December-March covering 60%. Similarly, the September-November soybean futures spread was covering 73% as compared to the November-March spread covering 61%.

How can we use the information in the down escalator simulator? As we make our way into and through the fall quarter of 2024 (September through November), we can expect the calculated full commercial carry in nearby futures spreads to continue to strengthen. This tells us the commercial view of supply and demand is expected to grow more bearish, not earth-shattering news given harvest will get rolling and move toward its end during the next seasonal quarter. Those on the commercial side holding short futures hedges can look for opportunities to roll these positions forward (e.g. November to January soybean hedge positions, December to March for the other markets) to take advantage of the stronger carry and wait for basis to appreciate over time.

Unless something happens to change supply and demand, giving us something to watch over the coming months.

Endnotes

1. Along with the August issue, making up the Jar Jar Binks contracts of the soybean futures market. What does this mean? Combined, the August and September issues make up an unnecessary and unfunny comic relief that is infinitely annoying.
2. Long considered a hybrid futures contract, part old-crop and part new-crop.
3. The Goldilocks Principle: Daily charts are too hot, monthly charts are too cold, but weekly charts are just right.
4. Unless we apply the marketing-year misdirection: Marketing years only existing for accounting purposes. Supply and demand is fluid and always changing. A subject for further discussion at another time.
5. Gary used to say something to the effect of, “Weather patterns tend to change with the seasons.”