Last week was remarkable for the grain markets, particularly corn. Corn had its biggest one-week gain in more than 10 years. What was most remarkable was that this move took place during the harvest.

There hasn’t been a move like this in the thick of the harvest in more than 100 years. A perfect storm came together, consisting of a bullish crop report (while most people were looking for a rise, the US Dept of Agriculture lowered its crop-size estimate), a bullish wheat market that helped sympathetically boost corn prices (due to the Australian drought), and massive short covering.

Due to expectations of a big crop, many analysts had been bearish on corn in recent weeks and were looking for the normal harvest break. The shorts were certainly caught off-guard last week; remember, short covering can also be described as new buying, which can add fuel to a bullish fire.

In the August 21 Commodities Trends, Fortunes Made: Repeat In The Making?, I made the case for an uncharacteristic August price bottom for corn with my prediction for a dramatic demand-led bull market to follow:

Today, I see signs of complacency among corn buyers similar to those of the summer of 1995. The 1995-96 bull market was a classic demand-driven rally. The factors setting up today are, in my opinion, parallel to the factors that caused that dramatic bull move. Similar to the 1995-96 market, I believe the dynamics are in place for the next classic demand-driven bull market in corn.

Source: Commodity.com

The unprecedented new demand coming from ethanol production was part of the reasoning behind my prediction, but it’s not only ethanol. Export demand for corn is up more than 40 percent versus a year ago, and feed usage is higher, too.

What now? I see much higher prices to come longer term because, at current usage rates, the US could technically run out of corn late next year. Higher prices are needed to ration this future demand. Shorter term, however, the market feels as if it’s running up too far, too fast, and I see a price correction in the cards.

I’d like to turn now to something related--but completely different--and discuss what I’m looking at as another potentially lucrative opportunity.

Wheat has had an extraordinary month, in large part because of the Australian drought. As you can see on the weekly chart below, wheat has rallied more than $1.50 per bushel in just the last four weeks; this equates to more than $7,500 per futures contract (margin deposit currently $1,688 per contract).

Weekly Wheat--Chicago

Source: Commodity.com

Chicago wheat is soft, red winter wheat, a variety used for cakes and pastries. Wheat is also traded in Minneapolis, though of a different variety: hard, red spring wheat used for such products as French bread and hard rolls. Normally, Minneapolis wheat will trade at a higher price than Chicago wheat because it’s a premium variety with higher protein levels. Last summer, December Minneapolis wheat was trading $1 (100 cents) above December Chicago wheat. In mid-July, December Minneapolis wheat was at $5.40 a bushel and Chicago was at $4.40.

Spread--December Minneapolis Minus December Chicago

Source: Commodity.com

This spread collapsed on the spectacular wheat-price rise in Chicago the last few weeks. On Friday, December Chicago closed at 526 while December Minneapolis closed at 522. In other words, Minneapolis went from 100 cents above Chicago to 3 cents below. This is way out of line and creates an opportunity.

Why is this spread so out of line? I believe it’s because the Chicago market is more than 10 times as large as the Minneapolis market and is the preferred trading venue for large-fund buyers. The fund buyers wanted to buy wheat when news of the Australian drought became known, and, frankly, many of them don’t know the difference between Minneapolis and Chicago; it’s all wheat to them. So they piled into Chicago and pushed the spread out of line. How out of line is the spread?

Spread--Minneapolis Minus Chicago--10-Year Chart

Source: Commodity.com

The spread was above zero 98 percent of the time during the last 10 years, and there was only one other period when Minneapolis wheat traded at a lower price than Chicago wheat. This was during the 1995-97 period; as you can see on the chart, Minneapolis was below Chicago for only a short period, corresponding to a time when there was a large Minneapolis wheat supply and a short Chicago crop.

But that’s not the case today.

Due to a drought in the Dakotas last summer, where the bulk of spring wheat is grown, there was a short Minneapolis crop this year. The Chicago crop, grown in the Midwest, was more normal. When fund buyers start to bail out of their Chicago wheat--and/or when the real users of spring wheat show up--look for the spread to move back to what’s considered normal, with Minneapolis prices well above Chicago prices.

The way to capitalize in the marketplace is to buy Minneapolis wheat and simultaneously short Chicago wheat. Profits on a spread are made on the relative difference in price. For example, if you entered this spread at even money (Minneapolis and Chicago wheat trading at equivalent prices) and exited with Minneapolis wheat 50 cents per bushel over Chicago wheat, the return would be $2,500 per spread minus commissions. There’s risk of loss in spreads, as in any futures trade, and the position must be monitored.

What I’d like to see before I issue a new trading alert for Futures Market Forecaster subscribers to enter this spread is a turn in momentum, with Minneapolis wheat once again moving above even money.

Then we go with the flow.

© 2006 George Kleinman
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