Hedging Canadian Wheat in the MGEX Hard Red Spring Wheat Futures

The North American wheat markets are well integrated which makes it possible to hedge Canadian spring wheat in the MGEX Hard Red Spring Wheat (HRSW) futures contract. The following graphs and data show the relationship between Canadian prices (or prices representative of Canadian locations) and the MGEX futures prices.

Thunder Bay, Domestic Milling Prices1

In Canadian dollars (CD) per metric ton (MT), the Canadian Wheat Board’s (CWB) quoted price for domestic 13.5% protein milling wheat at Thunder Bay tracks the MGEX nearby futures price very closely. The correlation in weekly price changes from 2006 through 2012 is 0.81 which suggests that the MGEX serves as an effective hedge even over short horizons. The cash-futures basis is relatively steady with an average of CD 59.10/MT from 2010 through 2012.

MGEX Futures and CWB Thunder Bay Quotes, 2010-2012 $550 $500 $450 $400 $350

CD/MT $300 $250 $200 $150 $100 Jan-10 Jan-11 Jan-12 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12

Thunder Bay MGEX Futures

CWB Thunder Bay Basis, 2010-2012 $160

$140

$120

$100

$80 CD/MT

$60

$40

$20

$0 Jan-12 Jan-11 Jan-10 Sep-12 Sep-11 Sep-10 May-12 May-11 May-10 Date

St. Lawrence, Export Price1

The CWB export price for 13.5% protein HRSW is highly correlated with the MGEX nearby futures.2 The correlation of week-to-week price changes is 76%. This indicates that hedging at short horizons (one week) would be effective at reducing risk. Generally, the hedging effectiveness and correlations will increase as the hedge horizon increases. Therefore, hedges held for more than one week would have an even greater correlation. The basis for the CWB St. Lawrence quotes averages CD 93.45/MT from 2010 to 2012.

MGEX Futures and CWB St. Lawrence Quotes, 2010-2012 $550 $500 $450 $400 $350

CD/MT $300 $250 $200 $150 $100 Jan-10 Jan-11 Jan-12 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12

St. Lawrence MGEX Futures

CWB St. Lawrence Basis, 2010-2012 $160

$140

$120

$100

$80 CD/MT

$60

$40

$20

$0 Jan-10 Jan-11 Jan-12 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12 Date

1 Canadian Wheat Board (CWB) prices are from Agriculture Canada’s Weekly Price Summary (http://www.agr.gc.ca/pol/mad-dam/index_e.php?s1=pubs&s2=pri). The CWB wheat prices were discontinued as of April 27, 2012 as the Canadian marketing system transitioned away from the Board marketing system for wheat. Discussions with analysts with Agriculture and Agri-Food Canada revealed that under the new system there still has not emerged a reliable and consistently quoted price for country locations or interior shipping points. 2 MGEX HRSW futures prices were obtained from the Minneapolis Grain Exchange (www.mgex.com). 2

Northeast Montana, Elevator Prices3

As a proxy for Canadian country elevator prices, the USDA’s Northeast Montana quote for 14% protein spring wheat is utilized. Assuming prices in the Canadian prairies are comparable to US prices, Canadian farmers can expect a correlation of 88% between week-to-week changes in country prices and the MGEX futures. Moreover, the basis should average around CD -3.25/MT under the nearby futures price.

MGEX Futures and NE Montana Prices, 2010-2013 $450

$400

$350

$300

CD/MT $250

$200

$150

$100 Jan-10 Jan-11 Jan-12 Jan-13 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12

NE Montana MGEX Futures

NE Montana Basis, 2010-2013 $60

$40

$20

$0 CD/MT

-$20

-$40

-$60 Jan-10 Jan-11 Jan-12 Jan-13 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12 Date

3 U.S. prices were obtained from the USDA Agricultural Marketing Service. 3

West Coast, Portland Prices

As a proxy for the West Coast export markets, the USDA’s Portland (delivered, train) quote for 14% protein spring wheat is utilized. Assuming Vancouver prices for Canadian spring wheat comparable to US West Coast prices, then Canadian merchants can utilize the MGEX spring wheat prices for hedging. Despite a few missing observations, the Portland prices show a week- to-week correlation of 0.89 with the MGEX futures. The Portland basis is consistently around CD 51.00/MT.

MGEX Futures and Portland Prices, 2010-2013 $500

$450

$400

$350

$300 CD/MT $250

$200

$150

$100 Jan-10 Jan-11 Jan-12 Jan-13 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12

Portland MGEX Futures

Portland Basis, 2010-2013

$120

$100

$80

$60 CD/MT

$40

$20

$0 Jan-10 Jan-11 Jan-12 Jan-13 Sep-10 Sep-11 Sep-12 May-10 May-11 May-12 Date

Recent Evidence and New Canadian Quotes

During the transition away from the CWB as the exclusive marketer of Canadian wheat, Agriculture and Agri-Food Canada’s Weekly Price Summary began to record new CWB spot prices for two locations: Thunder Bay and Vancouver. While there is not enough data for a reliable statistical analysis, a presentation of the basis in table form (below) shows a relatively stable basis relationship at these two locations.

CWB Spot Basis for 13.5% Protein, Canadian Western Red Spring Wheat and USDA Quote for 14% Protein, Portland (CD/MT)

Week Thunder Bay Vancouver Portland 8/3/12 ‐0.47 12.36 17.93 8/10/12 ‐0.78 11.95 17.36 8/17/12 7.21 19.90 16.80 8/24/12 ‐1.92 10.80 17.55 8/31/12 2.74 17.19 20.18 9/7/12 6.23 20.58 17.53 9/14/12 9.12 23.35 18.28 9/21/12 3.44 17.77 18.23 9/28/12 3.39 17.73 18.94 10/5/12 ‐6.68 7.63 22.05 10/12/12 ‐5.05 9.30 25.39 10/19/12 3.97 16.72 26.12 10/26/12 ‐2.65 8.28 31.76 11/2/12 ‐1.08 8.64 32.39 11/9/12 ‐0.69 10.98 32.30 11/16/12 ‐4.79 8.32 32.73 11/23/12 3.31 11.07 32.87 11/30/12 9.53 13.93 33.97 12/7/12 6.63 9.32 30.20 12/14/12 5.30 7.21 29.89 12/21/12 4.39 14.05 30.06 12/28/12 5.48 14.66 29.71 1/4/13 1.40 10.91 32.12 1/11/13 6.42 23.16 32.46 1/18/13 6.68 21.21 33.43 1/25/13 11.09 26.19 33.82 Average 2.78 14.35 26.31

The evidence presented in the table suggests that the Thunder Bay quote will average a price fairly close to that of the MGEX futures price with a basis averaging CD 2.78/MT.

Of particular interest for the export market, the Vancouver quote has averaged CD 14.35/MT with a range from roughly CD 7.00/MT up to CD 23.00/MT. This is reasonably close to the CD 26.31 averaged at Portland and the difference likely reflects the higher protein content (14%) of the Portland quote.

As shown in the following figures, the Vancouver quote trends closely to the MGEX futures which results in a stable basis level that is usually between CD 10.00 and CD 20.00 for this export terminal.

Collectively, these data suggest that the MGEX spring wheat futures contracts are tracking the new CWB spot price quotes and are likely to provide effective hedging tools in these markets.

MGEX Futures and Vancouver Prices, 2012‐2013 370

360

350

340 CD/MT 330

320

310

300 8/3/12 9/3/12 10/3/12 11/3/12 12/3/12 1/3/13 2/3/13 Week Vancouver MGEX Futures

Vancouver Basis, 2012‐2013 30

15 CD/MT

0 8/3/12 9/3/12 10/3/12 11/3/12 12/3/12 1/3/13 2/3/13 Week

Correlations and Currency Considerations

The above analysis assumes that hedges are in a common currency. The correlations were run for weekly price changes assuming a currency hedge (common currency) and without a currency hedge (across currencies). The correlations are presented below for data from 2006 through 2012.

Common Across Currency Currencies Thunder Bay 0.81 0.80 St. Lawrence 0.76 0.74 NE Montana 0.88 0.82 Portland 0.89 0.88

The correlation in weekly price changes declines by 0.01 to 0.06 when hedges are placed across currencies as opposed to in a common currency. Even without a currency hedge, the correlations range from 0.74 to 0.88. This suggests that over weekly horizons the MGEX spring wheat futures can be effective risk management tools for Canadian producers, processors and end users even if the hedges are placed across currencies.