Mecardo Analysis - Black Sea futures for Australian hedging?

By Andrew Whitelaw | Source: CME, Mecardo

The last few years have seen the rise of the Russian steamroller. A series of strong production years in the Black Sea region have led Russia to become the world’s largest exporter. In a typical year Australia is overwhelmingly an exporter of wheat, so it makes sense to examine whether the newly released Black Sea futures offer value for hedging our wheat.

At Mecardo we always think it is important to re-examine the market, as we cannot always stick to the same methods when it comes to our risk management strategy. What works one year will not necessarily work the next.

This analysis has been produced to examine the correlations between futures contracts and our local wheat price. In this instance, I have chosen to consider the relationship between CBOT, Black sea and our local APW price.

To maintain a similar delivery period, the December 2018 futures contracts and the 2018 APW multi-grade harvest price have been utilised. The timeframe chosen for this analysis was from mid-April (seeding) to present. This was due to the lack of pricing pre-seeding in Australia.

The correlation of two data series is used to determine the strength of the relationship between pairs. As an example, if two prices rise in line with one another it would be considered a strong correlation with the potential for their price movement to be related.

There are two ways of calculating correlation, by using the nominal price or by the change in price. The most statistically appropriate method for analyzing a time series of prices is the change in price. Nonetheless we will examine both.

In figure 1, the change in price as a percentage on a weekly basis between CBOT and Port Kembla is displayed. In figure 2, the same is shown for Black Sea futures. We can see that from a visual inspection they tend to follow one another relatively closely.

However, the chart doesn’t tell the entire story. In table 1, the correlations for both the static price and the change in price are shown for several Australian ports. A perfect correlation is 1, and no correlation is 0.

I have highlighted the highest correlation for both nominal price and change in price. Interestingly the Black Sea futures have the highest correlation for static accounts, whereas it changes to CBOT when the price change is used.

Key points

   * The correlation between prices is used to determine the strength of a relationship with 1 being a perfect relationship.

   * The Black Sea futures and Australian prices have a strong relationship when examining the nominal price.

   * The change in price is a more statistically valid for calculating a correlation for a price series. This method shows that CBOT has a higher degree of correlation with Australian prices.

What does this mean?

It is important to ensure that appropriate statistical methods are utilized. If only the nominal price was used the Black Sea price would have the higher degree of correlation.

In our examination of the period from seeding to present, we can see that CBOT has the highest degree of correlation. This means that there is a stronger relationship between CBOT and Australian prices at present.

The Black Sea contract is relatively new and this may change into the future. It will be interesting to follow this over time.

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