Kansas City Wheat on the Move versus Chicago Wheat

August 11, 2014

As written for CQG.

Kansas City Wheat on the Move versus Chicago Wheat

The memories of a frigid winter have melted into the summer heat across the US. It has been a great summer for grain production; the weather has been temperate with corn, soybean, and wheat crops all thriving. Grain prices have fallen; so far they are all close to four-year lows given the crop progress.

The most followed and watched wheat contract is traded on the CBOT – it represents soft red winter wheat. Hard red winter wheat is traded on the Kansas City Board of Trade (KCBT). Bread manufacturers in the US tend to price their wheat requirements based on the KCBT wheat contract.

This past winter, the hard red winter wheat crop suffered severe damage due to the cold. As winter turned to spring and crop damage was assessed, the price of hard red winter wheat soared along with the premium of the KCBT wheat contract when compared to the CBOT contract.

wheat1.png

As the daily chart illustrates, KCBT wheat traded up to a premium of $1.30 to CBOT wheat during the month of June.

wheat2.png

The weekly chart of this relationship shows a number of price spikes in the premium between the two wheat futures contracts. Over a long period of time, the median premium for KCBT wheat over CBOT wheat is around the 30-40 cent level.

There are two main reasons for premium increases: First, when there is a general increase in the price of wheat, bread manufacturers become concerned about high prices and run to the KCBT contract to hedge their future purchases. We saw this occur as a result of the 2012 drought when the premium traded up to the $1.50 level. The second reason, which we saw these past months, happens when there is damage to the red winter wheat crop itself.

Now that winter has faded into memory, this premium has started to drop. Over the past month the premium has decreased from $1.10 to 80 cents. It will most likely continue to drop back to historical norms.

Selling KCBT wheat and buying CBOT wheat on spread is a mean reversion trade with some juice still left in it at the 80 cent level. Chances are this spread will trade back to historical norms at around the 40 cent level.

 

CQG Article: Kansas City Wheat on the Move versus Chicago Wheat


Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities.

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