March 23, 2012

Buy Wheat – Sell Corn

The markets are not always (or ever?) rational, and there are definitely times when prices of individual commodities become ridiculously, unsustainably, high or low. Along the same lines, there are also occasions when classic price relationships between markets, known as “spreads”, become severely (and unsustainably) distorted, thereby presenting potential trading opportunities. One of the biggest such market distortions I have ever observed can be seen on the following 50 year chart of the spread between Wheat and Corn.

Wheat and Corn are both priced in cents per bushel. For various reasons (weight, nutritional values, usage, etc.), Wheat has virtually always been priced higher than Corn. This chart displays what the difference has been in this "spread" going back almost 50 years…and as you will quickly note, with the spread at 50 year lows, the relationship between the two could easily be classified as “severely distorted”…and therefore, I believe, MORE than ready for a return to  what has previously been the norm.

THIS IS A FUTURES TRADE ONLY. I AM BUYING JULY 2012 WHEAT AND SELLING JULY 2012 CORN.

If you research the “fundamentals” on this idea, to simplify, you will hear the same thing everywhere: “Wheat stocks are quite large, which is bearish (sell Wheat). Corn stocks are tight due to the ethanol mandate and Chinese buying, which is bullish. (buy Corn)”.

To this I respond, “ I am dead opposite those opinions. Tell me something new. I believe these factors are TOTALLY KNOWN and already incorporated in the markets.”

Between now and July, I would not be at all surprised to see both a rally in Wheat and a sell-off in Corn, which would be the perfect combination to see this trade work in a VERY big way.

The truth is, however, the only thing we really want to see is Wheat increasing in value relative to Corn…and I believe this will happen, regardless of whether they are both trending down, or up, from current levels.

One thing I very much like about this position? This spread has been an “attractive” idea for almost a year, and I would bet there are 1000’s of traders who are SICK of this trade after having lost a LOT of money waiting for it to happen…In other words, they probably want nothing to do with it…now when it is finally ready to go…We have all been there, where the market wears your ass out, and you give up…and then you find yourself watching it take off…without you…Maybe I’m dead wrong and will find myself in the same boat 3 or 4 months from now, but I absolutely believe this spread is IMMEDIATELY primed to start moving dynamically higher…and if this idea makes sense to you, you need to be on it NOW.

Here is a daily chart of the current July 2012 spread and one approach to doing it….

I would definitely recommend increasing the size of the position if this starts working…essentially looking to have tripled the original position by the time it closes over the 50 cent level.

I would add there are mini contracts which can be used here as well. Instead of the regular 5000 bushel contract, they are for 1000 bushels with a $600 per spread margin requirement. With the mini’s, each 1 cent move is $10, meaning a 22 cent risk would be $220, and $1 gain would be $1000.

From more perspective, here is what the two individual Corn and Wheat contracts look like…

And finally, there is this…How Speculative and Commercial Traders are currently positioned…

If this commitments thing is confusing to you, here’s the bottom line: The Speculative masses are overwhelmingly on the other side of what I am thinking. Commercial interests (producers and users of Wheat and Corn) are heavily positioned dead opposite the Specs…All things considered, and especially with that 50 year Wheat vs Corn chart in mind, I like my chances being on the same side of the Commericials…And while Commitments are NOT an infallible indicator I do really think this could be a big one.

Lastly, If you have trouble grasping the concept of how spreads work (buying one, selling the other?), give me a ring and I am pretty sure I can clear up any questions you might have.  

No mumbo jumbo…What I always try to do here is give you a straightforward, plain English summary of how I arrive at my conclusions…Hope everything here makes sense to you…

Give me a call if you want to talk about any of this, or any other markets…And as always, if you know anyone who might have an interest in this insanity, please do pass this newsletter along.

Thanks,

 Bill

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