Market Update - March 3, 2023

Hi everyone,

Welcome to the OpenDairy market update.

As promised, this week we will dive into the game of carry trades.

The physical spot market typically trades 2-4 months ahead in time, but derivatives markets show more liquidity beyond that time frame. This results into a forward curve, showing the bid and ask prices for futures per month in the future.

Here we show a simple forward curve for NFDM in the United States. In this case, forward contracts are priced at a higher level than the current month. This is called a contango and tells us the market expects higher prices in the future. The opposite would be a so called, backwardation, where future prices are lower than today's price.

We are comparing the cost price of buying physical product and storing it over time, against the futures return per month.

Whenever there is a contango in the market, there is an incentive to hold product and carry it towards the future settlement. It sounds technical, but it's very easy. You buy product today, store and finance it, and sell it when your future sale expires. In our example, this results in a profit of 150 US Dollar per metric tonne in September.

So why are we explaining all these trading strategies? We believe it's important to understand these trading strategies when reading commodity markets.

Fundamentals are a good tool to predict market movements in the long run, but recently we have seen very aggressive short term moves both up and down. By understanding these simple trading strategies, market moves are easier to explain.

As an example, we see limited demand from end buyers today, but also limited sales pressure with suppliers. The forward curve might be part of this reason. Whenever these spreads are traded, and diminished, the market will look for new directions. But the fact we see contangos across all products and exchanges certainly underlines the bullish expectations for 2023.

Sales pressure will build in the northern hemisphere the next few months, but the moment buyers will build and hold on to stocks is not too far away.