Mecardo Analysis - Charged up and ready to go

By: "Farm Tender" News
Cattle News
Apr 11, 2019
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By Andrew Whitelaw | Source: Mecardo, CME.

This article is bought to you by Australian Fodder Industry Association.

The northern hemisphere weather risk market is now upon us. In recent years this has provided ample opportunity to lock in strong pricing. In this article we look at how we did in previous seasons, and why it might be good time to consider a strategy for the mid-year period.

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Volatility is an important measure to maintain a close eye on. When referring to volatility we are discussing the movement of the marketplace. A more volatile market means that there are bigger swings in pricing levels. It is important to note that these swings can be both upwards and downwards.

In figure 1, volatility for the Chicago soft red winter wheat contract is displayed. This chart represents the seasonality of volatility, with the green banding being the standard deviation (or expected range).

At the start of the year, volatility dropped markedly to 16%, which is well below the average and expected range for the start of the year. This was due in part to the lack of solid data to drive the market in either direction. The volatility has however picked up and returning close to the average over the past decade.

The historical pattern is for volatility to increase through the northern hemisphere growing period until there is certainty on the condition of the crop. This is a pattern that is likely to repeat this year, but the question is whether that volatility will lead to higher or lower prices.

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In figure 2, the Chicago wheat contract is displayed. The futures contract during February fell dramatically dropping 12.5% since the start of the year. This is due to generally benign conditions being experienced throughout most of the worlds growing regions (See comment).

2019-04-11 Grain 1

The market appears to have found a floor and is trading in a narrow range at present. We are now at the start of the period where prices in recent years have started to rally on the back of weather woes. The volatility could provide opportunities for farmers to lock in prices.

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Key points

* Volatility was low at the start of the year but has returned to the expected levels.

* Volatility tends to rise in the middle of the year during the northern hemisphere risk period.

* In recent years the middle of the year has provided short term pricing opportunities.

What does this mean?

In recent years the middle of the year has provided strong rallies in pricing levels. These have largely been speculator driven events as a result of poor weather conditions which have typically not persisted to cause major impacts on crops.

These rallies have typically been short-lived and have resulted in much of the gains being lost by August/September. If we see very sharp increases in price, it may be a good time to lock in a small proportion of futures cover.

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