- While the Chicago (SRW) futures market has posted a sharp rally of late, the move has been driven more by funds short covering rather than a change in fundamentals.
- Total open interest in the market has dropped by almost 72,000 contracts the last two weeks, a bearish technical indicator for a rallying market.
- National average basis remains weak as well, the key factor in reading a market according to Grains Golden Rule.
I can honestly say that on my Bingo card of topics to be discussed during 2023, the bullishness of soft red winter (SRW) wheat was nowhere to be found. Yet here we are in early December, following a week when we watched the March futures contract rally nearly a dollar from the previous week’s low of $5.5625 (November 27) through last week’s high of $6.4950 (December 6). Along the way we saw USDA announce SRW sales four of the past five mornings, all to China and totaling 1,120,000 mt (41.2 mb). Recall I’m the one who always talks about listening to what the market is telling us, in the case of SRW wheat, can we believe what the market is saying at this time?
To answer this, I’ll apply Grains Golden Rule that Tregg Cronin, a friend of mine, used to talk about in his presentations. At one point in his career he had been a grain merchandiser for a large commercial firm, and one of the key thoughts he took away from the experience was what was known as Grains Golden Rule: First basis, then futures spreads, then futures. Not only does this act as a guide for tracking a market, it gives us all we need to analyze a markets bullishness or bearishness. After all, not every rally or selloff is what it looks to be.
With this in mind, let’s take the SRW wheat market apart piece by piece.
- Basis. The cash index I track for national average basis was calculated at $5.6015 on Friday, December 8. Meanwhile, the March futures contract (ZWH24) had closed that day at $6.3175. This put national average basis at roughly 71.5 cents under March futures. The previous 5-year low weekly close for last week was 51.0 cents under March, meaning this year’s basis market was about 20 cents weaker than its previous weakest reading in early December. That is not bullish, as it indicates merchandisers are allowing the rally in futures to source supplies to meet demand.
-
Futures Spreads. As you know, I view futures spreads as a key read on real market fundamentals, regardless of market. Since late September, the March-May Chicago (SRW) futures spread has seen its carry cut from 21.25 cents to this past Thursday’s 7.25 cents carry. As for the all-important cost of carry, the March-May spread covered (with 67% or more considered bearish, 33% or less considered bullish, and everything in between various levels of neutral):
- Nearly 91% at the end of September
- Roughly 75% at the end of October
- About 62% at the end of November
- And 36% at the end of last week
-
Futures. As I mentioned before, the March Chicago contract has rallied 93.25 cents the last two weeks. But again, not all rallies are the same. In this case, open interest in Chicago wheat was reportedly 430,318 contracts at the close of Friday, November 24, just before the contract fell to its low on Monday, November 27. Two weeks later, on Friday, December 8, total open interest in Chicago wheat was reported at 358,436 contracts, a decrease of 71,882 contracts. From a technical point of view, this is not bullish. Why? As John J. Murphy wrote in “Technical Analysis of Futures Markets” (1986 ed., pg. 193):
- “If, however, prices are rising and open interest declines more than seasonally, the rally is being caused primarily by short-covering (holders of losing short positions being forced to cover those positions). Money is leaving rather than entering the market. This action is considered bearish because the uptrend will probably run out of steam once the necessary short covering has been completed."
Has this rally in Chicago wheat been driven by noncommercial short-covering? A look at weekly CFTC Commitments of Traders reports (legacy, futures only) shows this to be the case (see chart above). As of Tuesday, November 28 noncommercial traders reportedly held a net-short futures position of 97,204 contracts. This was the largest net-short futures position in Chicago wheat since 98,684 contracts the week of December 19, 2017. The latest report showed this same group had decreased their net-short futures position to 67,067 contracts. A look at the chart shows spikes created by short covering in Chicago wheat are common, including shortly after the December 2017 position. That was one of the more dramatic examples as funds eventually moved to a net-long of 86,528 contracts (week of August 7, 2018).
If we break down the most recent change of 30,137 contract in the noncommercial net-short futures position we see funds increased their long futures by 5,258 contracts and decreased their short futures by 24,879 contracts. We can apply similar analysis to what we did with total open interest and see most of the change came from short covering rather than adding new longs meaning the change in noncommercial position is not as bullish as it seems.
The other ripple effect of short covering to this degree is it looks to have skewed the March-May futures spread. Funds generally hold nearby futures positions and as of early November, most of the short had been rolled from December to March. Therefore, if most of the short covering buying is occurring in the March issue the end result is March gaining an unusually large amount of ground on the next deferred May issue. Have commercial traders also been providing support? Yes, but in smaller quantities than what the futures spread indicates.
The most recent weekly export sales and shipments update, for the week ending Thursday, November 30 (the end of 2023-2024 Q2) showed total shipments of SRW wheat of 64 mb as compared to 62 mb for the same week last year. The math is easy on this one, as the pace of shipments projected total 2023-2024 marketing year shipments for US SRW wheat of 128 mb as compared to last year’s reported 99 mb. Before we get too excited, we have to keep in mind how dismal 2022-2023 exports were, with 2021-2022 reported shipments of US SRW wheat coming in at 102 mb.
Is SRW wheat bullish? No. Basis is still bearish, and futures spreads have been skewed by a rally in futures spreads driven by noncommercial short covering rather than new buying interest. Has export demand increased? Yes, but that doesn’t make a market bullish. Based on the same cash index I use for basis analysis, the end of November showed US SRW wheat available stocks-to-use to be 43.3%, in the bottom half of the range dating back 20 years. In the end, those are the numbers that really matter.
