Frustrated wheat traders who say the Chicago Board of Trade Soft Red Winter wheat contract is no longer an effective hedging tool appear to be testing the waters in a new market – the Minneapolis Grain Exchange.
Open interest in the MGE’s long-dormant, cash-settled Soft Red Winter Wheat Index futures has exploded over the last three weeks – jumping from zero on Sept. 25 to 1,258 contracts as of Oct. 16.
Traders say the burst of activity for the long moribund grain “index” contracts is directly tied to the travails at the CBOT, its parent the Chicago Mercantile Exchange and its regulator, the Commodity Futures Trading Commission. “It is a reflection of firms that want to do something other than hedge in Chicago and this includes some fairly well-known commercial names. Most of it I think seems to be spread activity versus Chicago,” said Rich Feltes, senior vice-president of MF Global Research in Chicago.
“Open interest in that contract is being helped along by the sequence of events in Chicago, including this likely approval of variable storage rates which many players simply do not see as the final answer,” he added.
Commercial grain companies have complained for more than two years that the CBOT wheat contract has broken down as a hedging tool, saying Wall Street investment flows that have inflated futures far above basic wheat supply/demand forces.
The result – a lack of convergence between cash and futures prices at contract expirations, an essential condition for hedging – has also vexed the CME and CFTC. They have tried various ways including higher grain storage fees to encourage more grain to move out of storage and into marketing channels.
CFTC is considering unusual new “variable” storage rates for the CBOT wheat contract. CME wants to install the new rates from September 2010 – nearly a full year later than a target date suggested by a CFTC panel. So actual implementation is still up in the air – and remains the wild card on pricing and timing that lashed CBOT wheat spread traders harshly in the last month as speculation on future storage costs whipsawed many into big losses.
“I think you’ve got the industry looking at this issue on convergence in Chicago that has woke people up – is there another alternative, a different choice?” Scott Cordes, president of brokerage Country Hedging and a member of the MGE board of directors, told Reuters.
Scott Hedin of St. Croix Commodities Inc., another MGE board member, attributed the sudden boost to “marketing opportunities for not only the speculative community but also commercial entities to capture some synthetic basis trading” using the SRWI market.
He added that a “general frustration with the Chicago confusion” had also helped boost interest in the SRWI market. The MGE’s grain index contracts are based on an index of cash prices collected daily from more than 500 grain elevators.
A huge, continual and abnormal discount of cash basis prices to the CBOT wheat contract in recent years – $1 to 2 or more per bushel – has been a huge problem for elevators. The spread tightened to about 70 cents at CBOT September wheat expiration but hedgers say it needs to improve.
A “synthetic,” paper basis position can be fashioned, say, with a sale of SRWI futures and a purchase of CBOT futures. “Predictable basis and reliable convergence between cash and futures markets” is touted for SRWI by the MGE’s website.
That element – cash rather than physical delivery – and much smaller speculative participation in MGE have held back the index contracts from getting much traction – until now.
“I thought we’d have seen some interest much earlier. But I think the trade was giving the CME a chance to fix their contract,” said one trader with commercial grain clients. “However, patience of the grain-handling community has run out and the majority of players are looking for other alternatives. This is how the SRW Index contract got its foot in the door,” the trader said.
A veteran MGE trader said: “My guess is from what I’ve seen they’ve convinced some market maker or some small hedge fund to spread that against the CBOT wheat contract with the idea they are so disgusted with the lack of convergence in Chicago Soft Red they want to show that this is a better tool.”