RSSGoin' to Kansas City...
By Brad Zigler | September 05, 2008 | 9:54 AM | 0 Comments
Wilbert Harrison put the City of Fountains in everybody's mind, and himself in the Rock ‘n Roll Hall of Fame, with his 1959 recording "Kansas City."
And now, nearly 50 years later, I find myself humming the tune as I prepare to head out to the Society of American Business Editors and Writers Fall Conference in ole' K.C.
At the workshop, I'll be on a panel questioning Secretary of Agriculture Ed Schafer on biofuels and leading a group of journalists on a tour of the Kansas City Board of Trade.
The "wheat board," as it's known locally, is the trading venue for futures on hard red winter (HRW) wheat. Primarily used in bread making, HRW constitutes the bulk of U.S. wheat production.
Most people are surprised to learn that fact. The Chicago Board of Trade has become synonymous with wheat trading, but the fact is that Chicago trades a different kind of wheat. Soft red winter (SRW) wheat is the basis grade for Windy City contracts and is used in the manufacture of cakes, crackers, snack foods and pastries.
Owing to its use in the production of a staple, HRW wheat's demand is rather price inelastic. SRW's demand, however, is largely correlated with changes in personal income. As incomes increase, consumption of the products that use SRW tends to increase apace. Ordinarily, HRW trades at a premium to SRW. For instance, the current difference in the bushel prices of December futures is 42 cents in Kansas City's favor.
KCBT Wheat (December 2008)
The premium, though, isn't static. It waxes and wanes, often in fairly reliable patterns. And that makes the premium a favorite target for spread traders. We're now, in fact, on the verge of a rather dependable seasonal move. The Kansas City premium typically widens in the fall owing to differences in growing area weather patterns. Over the last five years, for example, the spread widened an average 38% between September and December. Last year produced an outsized 163% gain, as the premium opened up from 54 cents per bushel to $1.42.
Such prospects make a long Kansas City/short Chicago spread particularly enticing when you consider the margin break the exchange clearinghouses grant. The initial margin requirement for an outright Kansas City wheat trade is $3,125. With the December delivery settling at $8.19 yesterday, the performance bond represents 7.8% of the contract's total value. Buy that contract against the sale of Chicago's December contract, however, and your requirement drops to only $1,840, a 4.9% effective margin rate.
If the Kansas City premium widens by its recent five-year average - some 16 cents per bushel -- you'd be looking at an $800, or 43%, potential return for a one-contract spread. Not bad for a three-month hold.
No guarantees, of course.
I'll have more to report from and about Kansas City next week, including reports on oil man-cum-energy savior T. Boone Pickens, Monsanto's (NYSE: MON) CEO Hugh Grant, and Joe Hinrichs, Ford Motor Company's (NYSE: F) head of global manufacturing.
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