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Should You Be In Or Out Of The Pool?

This is the third in a series of six articles FarmLink Marketing Solutions is writing for Grainews regarding Canadian Wheat Board (CWB) programs. FarmLink Marketing Solutions was asked to provide ideas on how to interpret and maneuver around the various prices and signals that producers face in marketing board grains. FarmLink has been involved with using these programs day in and day out on behalf of the farmers they represent for the past eight years. Instead of just reading about what a pricing option is, we’ll present a real-world example of the implications of choosing one option over another. The first two articles ran in the November 2010 and December 2010 issues of Grainews

Over the course of finalizing our strategy for marketing the 2010-crop wheat, we’ve recently solved a few mysteries about a variety of issues that came into play in Canadian Wheat Board (CWB) pricing during the month of December. With almost half the marketing year under our belts, it’s becoming clearer how changes made in 2010 to CWB programs are impacting price levels.

The extension of the sign-up deadline for the Fixed Price (FPC) and Basis Contracts to January 31 has allowed sellers to defer by a few months the decision about whether wheat is better off in or out of the pool. And with the wheat market rallying all through the summer and fall, the decision has been easily delayed.

As can be seen on the March 2011 Minneapolis spring wheat price chart (see Figure 1), the market has been very strong this season. During July alone, prices rose from $5.50/bu. to $7/bu., then broke sharply higher in August to almost $8.50/bu. After chopping around in about an 80-cent range until the end of November, the beginning of December saw a breakout to the upside.

At the time of writing on January 4, there was quite a bit of uncertainty in the short-term outlook for wheat, with an important Jan 12 USDA report coming up, and commodity markets in the midst of index fund rebalancing and big new money flows expected for the new year.

Through late November and December 2010, the market digested a fair amount of bullish news (worsening wheat crop conditions in Australia, for example). Minneapolis March futures gained about US$1.55/bu., or $57/t. The FPC gained only about half that amount during the same time-frame.

The chart below (Figure 2) plots instore FPC values for No. 1 CWRS 13.5 per cent on a daily basis between mid-November and the end of December. The trend is the similar to the futures chart above, but absolute price levels were being muted substantially through the CWB’s Adjustment Factor. The Adjustment Factor is used to reconcile sales values already made of wheat in the pool, with current pool cash-out values. As markets rise, it’s negative (since sales were made out of the pool at previous lower values), and when markets fall, it’s positive (to adjust lower current prices for previous sales made at higher levels).

Intuitively, we would expect to see the pattern between the FPC and the Adjustment Factor inversely related, which is exactly what is found in comparing the chart above with the blue line on the chart below (Figure 3) — the trends mirror each other.

This is where the CWB’s pricing pace calculation can be used. This figure, which represents the portion of the pool that has been priced, went from 40 per cent to 45 per cent during the first few weeks of December. The clawback in futures market gains is about the same. In other words, the $24/t FPC gain is about 40 per cent to 45 per cent of the $55 to $60/t that the futures market moved higher during the same time frame.

The CWB has also publicly stated that they will be 60 per cent priced by the end of January. This information can feed into a farmer’s decision about how to position the farm in the various pricing options before the end of the pricing window. For example, if you think the wheat futures market will rally during January, you would take a Basis Contract early in the month (locking in the current Adjustment Factor), because as the futures rise it will continue to claw back those gains, at an increasing rate.

Come next July, if you think the market is going to rise after the Adjustment Factor comes into play on August 1, you would have the choice to either take a Basis Contract, or a FlexPro contract.

Based on our experience with these prices over the past few years, and our communications with the CWB to dig into how their levels are calculated and why, it is safe to expect the inverse relationship between the FPC and the Adjustment Factor to continue in a similar pattern to what is shown above.

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