Wheat, in particular, represents an interesting opportunity. Wheat is the second-largest commodities crop in the world, behind only corn. It currently trades around $10 USD per bushel and is often subject to large volatility swings resulting from shortages due to global droughts and/or global hoarding.
Not All Wheats Are Created Equal: Chicago, Kansas City, and Minneapolis
Many investors do not realize that wheat actually trades on three different exchanges in North America: Chicago, Kansas City and Minneapolis.
The most popular type of wheat is soft red winter wheat, otherwise known as Chicago wheat because it trades on the Chicago Board of Trade. The 'winter' label refers to the planting cycle. Chicago wheat is planted in the winter, lies dormant over the winter, and is then harvested in the spring. 'Winter' wheat differs from that which is planted in the spring and harvested in the fall and is otherwise known as 'spring' wheat.
The 'soft'ness refers to the protein level. Lower protein wheats are described as 'soft'. Higher protein ones are considered 'hard'. Chicago wheat is a low protein wheat with excellent milling and baking characteristics for cookies and cakes. It is typically grown in southern Midwest states and Texas.
Hard red winter wheat is the second type of wheat and is often known in the industry as Kansas wheat because it trades on the Kansas City Board of Trade. Like Chicago wheat, Kansas wheat is planted in the winter and harvested in the spring. Unlike Chicago wheat, Kansas is used for higher starch content applications like the baking of bread. This wheat is mostly grown in the Plains states.
Hard red spring wheat is the third type of wheat and is known as Minneapolis wheat because it trades on the Minneapolis Grain Exchange. This wheat is mostly grown in the northern states and Canada. Minneapolis wheat is the key ingredient for baking breads, rolls, croissants, bagels and pizza crusts. It is one of the hardest wheats and therefore has one of the highest protein counts.
Wheat Futures Market
In contrast to buying and selling equities on the stock market, an investor who enters into a futures contract does not exchange any physical money. A wheat futures contract simply carries with it an obligation to buy or sell at a certain price. Indeed, the investor has to post margin which is a capital outlay but this is to provide a level of assurance that the financial obligations of the futures contract will be met.
In effect, futures margin represents a good faith deposit. This is very different from equity margin which is a partial payment by the investor with the remainder being financed by a loan from the member firm. As futures margins provide contract integrity, they are essential component of the futures industry. Futures contract buyers and sellers can transact trades under the assumption that the financial integrity of the contract will be honoured.
All wheat futures regardless of the exchange are traded in lots of 5,000 bushels. When wheat trades for $10 per bushel, keep in mind that the value of one futures contract is actually worth $50,000 (ie. $10 * 5,000). Hence, an investor who enters into a futures contract is obligated to buy 5000 bushels of wheat at $10 per bushel. If the price of wheat goes up, the investor benefits because he/she can re-sell the wheat at the higher price. On the other hand, if wheat prices decline, the investor incurs a loss.
In reality, very few investors take delivery of wheat. Most investors simply liquidate their futures positions prior to the expiration date with the price difference representing the profit and loss. For example, an investor who enters into a futures contract at $10 and then sells it later for $12 will realize a total profit of $10,000 (ie. $2 * 5,000 bushels). On the other hand, if the futures contract drops to $7, the investor realizes a loss of $15,000 (ie. -$3 * 5,000 bushels).
'Fundamental Analysis' Trade
Fundamental analysis examines key components of the wheat futures market with attempts to understand cause and effect relationships between changes in supply and demand, which in turn influence the long term price. Traders who base trades on fundamental analysis take positions based on their outlook.
For example, a trader expecting a supply scarcity will go long the futures contract in anticipation that prices will increase. Likewise an increase in demand (all else held constant) will have a similar impact.
Typically, the USDA will estimate the number of bushels of wheat to be used and produced in any given year. The key measure tends to be the season ending carryover or the amount of supply not consumed in the current year. If current demand is expected to exceed supply, then suppliers will have to tap into stored stock and carryover will be reduced at year's end.
In most cases, fundamental analysis is aimed at uncovering long-term trends. In practice though, long term imbalances can take years to correct. There are many cases of a fundamental investor being "right in the long run" but having been wrong in the short term. The danger with fundamental analysis is that can take great conviction as well as deep pockets for an investor to stay committed and ride out fluctuations.
Commitment of Traders Report
The Commodity Futures Trading Commission gives some insight into buyers and sellers, and how money flows in and out of the wheat futures market with its Commitment of Traders Report. The CFTC reports monthly and records data broken down into one of three categories:
* Large speculators are large professional traders including banks and fund managers with an open interest of at least 1000 contracts.
* Small speculators are generally investors with a smaller amount of contracts than large speculators
* Large hedgers are bona fide hedgers consisting of commodity producers, factories and market makers.
Reviewing the Commitment of Traders Report can provide valuable insight into the wheat futures market. Some traders assume that large speculators are usually correct in their trading and will follow their lead. Others use the report as a contrarian indicator because large speculators can have a big impact on prices if they decide to liquidate their positions.
'The Seasonal' Trade
Like most agricultural crops, seasonal trends in the wheat market tend to be based on factors of production, supply interruptions and weather related considerations. Seasonality is the tendency of certain markets to show weakness and strength at certain times of the year on a reliable basis. Many traders will often create seasonal charts by averaging the weekly returns of the index over the historical period. Analysts will often overlay annual charts upon each other and visually look for season patterns.
'The Intercommodity Spread' Trade
Spread traders attempt to identify market situations where the price relationship between two related assets is expected to change. This often requires the analysis of historical market activity and graphing spreads over time. Traders who engage in spread trades do so because they feel there is an opportunity to buy the "cheap" wheat and sell the more "expensive" wheat, hoping the spread will revert back to its historical norm. An inter commodity spread trade involves the purchase of one futures contract on one wheat exchange and the sale of another futures contract on a differing wheat exchange.
Generally, Minneapolis and Kansas wheat will trade at a premium to Chicago wheat due to their higher protein content but this premium often fluctuates over time. Investors can trade this spread rather than take an outright view of the wheat market.Read More... For the latest updates PRESS CTR + D or visit Stock Market news Today
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