I have had this conversation several times over the past week. Many of you are holding old crop Spring Wheat contracts that were (might still be) priced against the July Futures contract. In most cases we intentionally set these contracts up this way with the expectation that we would price them out into any sort of April/May/June rally caused by adverse weather, and in such a case we would be priced out by now. That weather rally was a no show until recently, and even the June rally we did get stalled out lower than the April 6 high making it difficult to pull the trigger. Within my client list many did scale in some sales of old crop wheat last week, overall approx. 25% of open basis contracts were priced leaving 75% to be rolled this week. Rolls are something that many people fear, and the implications of the roll are widely misunderstood. Not only by farms, but many in the grain industry have misconceptions about roll implications. I would suggest that most of the misunderstandings have been created by poor explanations from people within grain companies, I have heard and witnessed these conversations more times than I can count. Rolling contracts is not something I make it a habit of doing. However there are times where tactically using rolls can benefit you, and there are times where rolling simply means taking more time in the market to lock in your price with minimal cost. This instance with Wheat is the clearly the latter (past Canola rolled through inverse is an example of the former). We have not seen a weather rally to motivate pricing, I accept that the probability of such a rally decreases after mid June, but there certainly have been summer weather rallies many times in the past. From this point forward rallies are usually caused by drought or abnormally high temps. When deciding whether or not to establish prices for your grain it is not only about what upside potential exists, but also about how much downside risk you are willing to tolerate. Upside potential is unclear, and if it does happen it will be caused by something that is not yet known. Downside in this case seems somewhat more predictable. Wheat charts have for the most part shown signs of bottoming, although not necessarily bullish, fundamentals of supply and demand are forecast to level off, and Year End stocks for 2014 crop year are unlikely to change much from this point on. With these things considered I continue to be willing to take some downside risk in return for unknown upside potential. Rolling these Wheat basis contracts is one way to accomplish this.

First let’s consider why I am willing to recommend continuing to have downside risk. The #1 reason I feel we are at or near the bottom of this move is based on where we reside in historical percentiles. The panic of grain markets and traders that occurred in late 2007 and early 2008 shows how wild things can get when a primary food source appears threatened. Following that panic grain markets quickly came back to earth, but “bottomed” at a level above all but a short period in 1996. As time has gone by I have for this, and several other reasons considered post 2007 to be a new era of grain prices. We currently sit slightly above the 5 ad 10 year lows, I do not see dramatic enough bearish news occurring during the summer months that would push us to, or through those levels. Take note I referred to the summer window, if we get to fall and manage to produce a bumper (trend line or higher) crop, testing those lows becomes more likely. Long story short, I believe we are near the bottom of likely range which should keep selling slow and provide strong support.

Source: Barcharts.com

Source: Barcharts.com

The second technical signal that gives me some optimism that we have formed a bottom is on the 6 month chart we achieved both a higher high, and a higher low on two recent moves. Now this does not guarantee we cannot break to the downside, but it does provide support to the argument of transitioning from bearish to neutral, or very mildly bullish. If you look at the trajectory of the support and resistance lines you see how slight the bullishness might be.

Source: Barcharts.com

Source: Barcharts.com

Also you will know by now I place highest weighting of my analysis on fundamentals. Supply and demand of course is global based, but we are most closely related to, and our futures are based in the US. For that reason I will look just at ours and the US numbers in this case. There will be a final seeded acreage reports out from USDA and StatsCan soon, but for today’s sake of argument I will use my March outlook data. For now I see the 2015 US all wheat carry-out decreasing by a small 5%, based on a 5 year average yield. 1 bushel per acre more could neutralize carry-out, 2bpa could be argued as bearish vs last year. In any case it is nearly impossible to create a scenario with even close to the 863-975 million bushel carry-outs that were around when we bottomed below today’s futures back in 2009-10. So from this data I conclude that it is unlikely that prices should fall as low as they did when there were 30% larger carry-overs.

Commodity Wheat                
2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 DLN 2015-16
Area Seeded (million acres) 60.5 63.6 59.0 52.6 54.3 55.3 56.2 56.8 55.5
Area Harvested (million acres) 51.0 56.0 49.8 46.9 45.7 48.8 45.3 46.4 47.0
Yield (bu/ac) 40.2 44.8 44.3 46.1 43.6 46.2 47.1 43.7 45.3
Production (million bu) 2051.1 2511.9 2208.9 2163.0 1993.1 2252.3 2135.0 2025.7 2128.6
Beginning Stocks (million bu) 456.1 305.8 656.5 975.6 863.0 742.6 717.9 590.3 690.9
Imports (million bu) 112.6 127.0 118.6 96.9 112.1 122.8 168.6 160.0 132.1
Total Supply (million bu) 2619.8 2944.7 2984.0 3235.6 2968.2 3117.7 3021.5 2775.9 2951.7
Exports (million bu) 1262.6 1015.4 879.3 1291.4 1051.2 1012.1 1176.2 900.0 1086.2
Domestic Consumption (million bu) 1051.4 1272.8 1129.1 1081.2 1174.4 1387.7 1255.0 1185.0 1216.7
Total Demand (million bu) 2314.0 2288.2 2008.4 2372.6 2225.6 2399.8 2431.2 2085.0 2302.9
Ending Stocks (million bu) 305.8 656.5 975.6 863.0 742.6 717.9 590.3 690.9 648.8

The Wheat picture here in Canada could actually be considered bullish with ending stocks next summer projected at a little over half of what we are at this year. I believe that the world trades our crop combined with the US crop, and when you put the two together we are still within one or two bushels per acre of a flat result year over year. The relative fundamental bullishness of Canada vs US wheat will (and already has been) shown in basis levels.

All Wheat 2014-2015 2015 DLN StatsCan 2015
Seeded Acres ‘000 24188.6 23696.0 24891.1
Harvested Acres ‘000 18720.5 18854.2 19805.1
Yield (bu/ac) 46.0 45.6 45.6
Production (‘000 MT) 29280.8 23398.4 24578.5
Imports (‘000 MT) 50.0 65.0 65.0
Total beginning stocks (‘000 MT) 9652.1 9232.9 9232.9
Total supplies (‘000 MT) 38982.9 32696.3 33876.4
Total domestic use (‘000 MT) 8750.0 8500.0 8500.0
Total exports (‘000 MT) 21000.0 19550.0 19550.0
Total demand (‘000 MT) 29750.0 28050.0 28050.0
Total ending stocks (‘000 MT) 9232.9 4646.3 5826.4
Source: StatsCan and DLN AgVentures

Therefore, in conclusion, I see the North American wheat fundamentals in agreement with the technical signals I listed above. Fundamentally market should take a neutral to very mildly bullish tone going forward. Therefore I make the recommendation to go ahead and roll to the Sept or Dec futures. Set reasonable targets and plan to scale out of these basis levels pricing portions on rallies when resistance is encountered.


Q: What does a roll really cost?
So now that we understand why we are taking this step, let me try to answer the question stated in the subject of this article.

A: $0.01-0.03bu, or $1.00-3.00mt depending what grain company and what grain you are rolling. Cost should be consistent and should be stated somewhere in the fine print of the grain contract.

 

Simple as that seems I would guess that most of the industry is poorly trained, or not very skilled in their terms when explaining. For example I saw this explanation the other day:

“July futures are $5.61 and Sept is $5.70 so that put us in a carry market, so to roll your charged the $0.09 bu off the basis plus the $0.03 admin fee.”

This explanation came from an experienced buyer who knows well how markets and contracts work and is among the better buyers I know, please don’t feel that I am picking on anybody here. I suspect that most have been taught to explain a roll this way. The error I see is in terminology and incompleteness of explanation. The term “charged” implies a cost to the customer which the customer then assumes is a revenue to the grain company. When you continue with “off the basis” it seems to confirm that it is indeed a charge from the grain companies to be paid by the farmer, and when you conclude with “plus the $0.03 admin fee” it seems crystal clear that the cost of this roll is $0.12 per bushel. What the explanation doesn’t make immediately clear is that when you roll from July to Sept you are now pricing off of the Sept, and therefore gain $0.09bu on the futures. The grain company is not “charging” you the $0.09bu at all, they are simply removing the  gain in futures by widening basis the by same amount. Your net cash price on the contract only changes by the admin fee.

Current Contract Value in Example
July 15 Futures 5.61
Basis 0.00
Net Price $5.61
Post Roll Contract Value in Example
Sept 15 Futures 5.70
Basis -0.09
Admin Fee -0.03
Net Price $5.48

This should be the case in almost all cases. Be careful about comparing what you are quoted with what you see on Barcharts or elsewhere as reporting delays and other issues can muddy the water. What you are quoted will be the spread from the grain companies systems pulled from actual futures markets in Chicago, Minneapolis or Winnipeg. The point I am trying to get across is that the roll itself is not at all expensive, and is consistent.

Where the fear of rolling comes from is personal or second hand experience of rolling in bearish or neutral markets. As I hope is clear now your price does not immediately change, but you have done nothing to protect your downside, and you remain committed to a basis. If Sept futures in this example close neutral to where July closed on this day (5.61) you will have lost 0.09bu. NOT PAID to anyone, simply lost to the market. If market trends lower you continue to lose until such time as you lock in price.

Bearish Market Example
Sept 15 Futures 5.35
Basis -0.09
Admin Fee -0.03
Net Price $5.23
Break Even Market Example
Sept 15 Futures 5.73
Basis -0.09
Admin Fee -0.03
Net Price $5.61

This scenario is frequently made even more painful because in neutral or bearish futures trends buyers tend to have to narrow in (improve) their basis levels to keep sales coming to them. So you end up not only losing the carry to the market, but end up receiving less than posted cash basis when you do finally lock in. This is why I don’t make a habit of rolling out of “hope” for better futures. I recommend rolling when I see limited downside risk (or when I am trying to capitalize on changes to spreads between contracts like in Canola this spring). Really to benefit from a roll you need to be bullish because you need market to rise enough to cover your Admin charges to break even, and above that to see a real benefit.

Beneficial Market Example
Sept 15 Futures 5.85
Basis -0.09
Admin Fee -0.03
Net Price $5.73

I do my best to simplify these concepts, at times that can be difficult. I am always available to provide further explanation. Please never hesitate to ask. These concepts and the terminology is easily misinterpreted and misunderstood, it is always a good idea to ask a couple of extra questions and not stop until you feel confident that you are clear on the implications of every contract decision.