Commodity prices often exhibit recurring seasonal patterns. While this is most often true for agricultural commodities, which are affected by growing and harvest seasons, and contracts such as heating oil, which are tied to seasonal weather patterns, seasonal patterns exist in other contracts as well. These relationships are widely discussed and written about in trade journals, newspapers and newsletters.
For most U.S. farm commodities, the annual harvest falls within a fairly well defined few weeks or months. Farmers are prone to sell a substantial part of their crop at harvest time, largely to meet production loans coming due, the costs of new machinery, the cost of land preparation for the new crop, fertilizer costs and other expenses. A portion of the crop, however, may be held in farm or local elevator storage, possibly under the protection of a federal crop loan, awaiting a potentially higher market in the months ahead. In any case, the concentrated selling during the harvest tends to put pressure on cash prices at that time of year. If the crop is large enough to satisfy normal requirements, buyers are not eager to accumulate supplies quickly. The net result is usually a seasonal price decline that tends to coincide with the advent of, or follows soon after, the harvest period.
As cash prices weaken, so do the near-month futures prices. Farmers and dealers who expect to sell the physical commodity within a few weeks or months will tend to hedge in the nearby delivery month. If prices of the nearby futures delivery month do not decline to near the level of the cash market, the owners of inventory will deliver their inventory against the short futures position, as they will make a greater profit by doing this than by selling their cash commodity through the usual commercial channels. Normally, the process of selling the near futures month will continue until its price has declined to a level equivalent to that prevailing in the cash market. This tends to depress the price of the nearby futures contract relative to the prices of the more distant delivery months and may be expected to continue as long as nearby cash market supplies of the commodity are ample and storage space is available.
The more distant futures positions are not usually under this type of selling pressure. Furthermore, once the major part of the harvest movement is out of the way and country selling diminishes, it is normal for prices to firm. With prices expected to be higher later in the season, the more distant futures positions tend to receive buying support. This tends to create higher prices for these contracts and sets up the carrying-charge structure of intermonth price relationships.
These seasonal price patterns are more consistent for some commodities than for others. Furthermore, the timing of seasonal lows and highs (especially the former) may be distorted by a number of considerations. For example, extended adverse harvesting weather may result in a later-than-usual seasonal low price, or a sufficiently drawn-out harvest period may diminish the impact of the harvest on prices. Conversely, an unusually early harvest can cause earlier-than-expected harvest movement and historically premature hedge-selling in futures. Even if harvesting occurs “on schedule,” a determined move by producers to hold production off the market (in the expectation of higher prices later) can forestall, if not prevent, seasonal downward pressure on prices. Under such circumstances the seasonal low price may be higher than expected, and seasonal gains from this level may be limited.
Keep in mind, also, that as with anything in the public forum, “predictable” price patterns are readily available to many people, and this fact is generally reflected in market prices. You should also be wary about seasonal spread recommendations giving precise target dates for establishing and closing positions. Often these target dates are based on past statistical relationships and cannot be counted on to repeat themselves in the same fashion in the future.
A better way to consider seasonal price patterns is using a fundamental approach. For example, as noted above, the supply of an agricultural good at harvest time is usually much greater than demand, which tends to depress prices. This results in a fairly regular widening or narrowing of the spread according to the season. Although this pattern might repeat for several years, you should not blindly initiate seasonal spreads. Care must be taken to determine whether current fundamentals support the anticipated action of the seasonal spread. When specific spreads are discussed in this chapter, it is important to keep in mind that the purpose is to outline the characteristics of the various spreads. These examples are definitely not recommendations. The spreads illustrated may or may not be logical or profitable in any particular year.
Historically, the long December/short July corn spread has been profitable from October through December.
Fundamentals: During the fall harvest, there is a tendency or the nearby December contract to be under tremendous pressure due to the wide basis levels. As the harvest pressure unwinds, the December contract tends to gain on the July contract of the following year. The fundamental factors that will affect the December contract are the harvest basis levels, the availability of storage and the cost of storage. In the example presented in the figure below, the 20-cent per bushel profit on the spread is realized by the December contract gaining on the July.
Time Spread of Corn Futures
Intercommodity Seasonal Spreads
An example of an intercommodity seasonal spread is long December wheat versus short December corn, both on the Chicago Board of Trade. The initiation date is about June 1, and the liquidation date is about November 1
Fundamentals: Wheat prices, both cash and futures, tend to be depressed at harvest time (midyear) for several reasons: supplies are greatest then, buyers tend to defer purchases at this time and farmers and other hedgers sell some of their wheat to pay harvesting costs. (This depressed price condition is particularly true when the wheat crop is considered large.) Later in the summer, when the wheat glut has eased and the potential size of the corn crop is known, wheat futures prices often firm while corn prices work lower in anticipation of the fall harvest. Thus, this spread can experience a “widening” of the price differential.
The spread between wheat and corn is not a typical intercommodity spread, such as that between oats and corn, because wheat and corn cannot readily be substituted for each other. The relationship between wheat and corn might be considered as one between contrasting seasonal price patterns. Further, the long wheat /short corn spread does not work well every year. You must carefully study prospective crop sizes and the probable demand in each market before placing spreads in any given year.
We can demonstrate an intermarket seasonal spread with a long September wheat position on the Kansas City Board of Trade versus a short September wheat position on the Chicago Board of Trade. The trade is typically put on in January and lifted during the June-August harvest period.
Fundamentals: Kansas City September wheat futures often have sold at a discount to the Chicago September wheat futures around March 1. This condition is often reversed during the midyear harvest period, when Kansas City wheat futures prices frequently move to a premium to Chicago wheat futures. The soft red winter wheat that grows in Ohio, Indiana and Illinois and trades on the Chicago Board of Trade is often sold on the open market by farmers rather than placed under a CCC loan. This tends to weaken cash and futures prices in Chicago at harvest time. But the hard red winter wheat traded on the Kansas City market is usually held off the open “free” market and is placed under CCC loan. This firms the Kansas City price in relation to the soft red winter wheat price in Chicago. A price chart showing the relationship of these two futures can be helpful in determining when to liquidate this spread.
When analyzing the potential of an intermarket spread, you must also consider freight rates between the markets, the normal direction of movement of the commodity, the availability of storage space at the respective terminal markets and the value of the deliverable grades of the commodity at each market.