1-10-2012 09:13 RPT-ANALYSIS-New position limits roil wheat spreads (Repeats with no change to text.

. Adds ANALYSIS to headline) * Two funds expected to roll positions out of MGEX wheat * Move to coincide with rise in CBOT, MGEX position limits * MGEX wheat tumbles versus CBOT on intermarket spreads By Julie Ingwersen CHICAGO, Jan 9 (Reuters) - Two Deutsche Bank-backed commodity funds could soon sell off their Minneapolis wheat contracts and double their holdings in Chicago as position limits are increased, a move that has roiled the wheat price spreads between the two markets. The traditional price premium for the high-protein spring wheat traded in Minneapolis over the more liquid but lower-grade soft red winter wheat traded in Chicago has eroded by about 10 percent since Thursday, accelerating a trend in place since mid-November. It's an ironic twist for the funds, which were caught up in an early crackdown on speculation more than two years ago. The two index-based exchange-traded funds (ETFs), with some $8 billion in assets, had been forced in 2009 to radically diversify their components after U.S. futures regulators said they would no longer be allowed to exceed federal limits on speculation in Chicago Board of Trade corn and wheat contracts. But those limits will be doubled from Jan. 17, the first rise in years, a move that in theory could allow the funds to wind down positions at the Minneapolis Grain Exchange -- which are not an explicit part of the underlying index benchmark -and swap back into the more liquid CBOT, analysts say. The prospect of the fund selling some 5,000 contracts of high-protein MGEX spring wheat futures <MWEc1> -- equivalent to about one-eighth of its open interest -- and buying some $215 million worth of the soft red winter wheat <Wc1> on CBOT, a tiny fraction of that market, is already making waves. "I think there are some people front-running that, and it's creating this weakness in Minneapolis," said Roy Huckabay with the Linn Group, a Chicago brokerage. The premium for MGEX over CBOT has tumbled from a mid-November high of $3.32-1/2 per bushel, to about $1.65 on Monday, narrowing by 24 cents in the last two sessions. Softening cash markets for spring wheat have pressured the spread, but traders said uncertainty surrounding the Deutsche Bank moves has added volatility. (Graphic: http://r.reuters.com/fet85s ) While the net result of the Deutsche Bank funds' moves won't make a difference to how much money they have invested in "wheat" overall, such a switch would add a footnote to the years-long debate over the roll of so-called "massive passive" investment funds in commodities, and for one of the funds that had been pinched by regulators seeking to get tough on speculators after the surge in food and fuel prices in 2008 provoked political and popular outrage. A spokeswoman for Deutsche Bank declined to comment for this story, citing regulatory disclosure rules. LOOSER LIMITS While other markets like oil and gold brace for new position limits approved last autumn by the Commodity Futures Trading Commission (CFTC), the situation is different for grains, which

have been subject to such restrictions for decades. The limits restrict the number of contracts a single speculative trader can hold. The caps on grain markets, broadly based on the number of open positions, had not been adjusted for years. As a result, many argued that the fixed limits had grown out of date as open interest in the wheat, corn and soy markets effectively doubled with the influx of billions of investment dollars. So last year, even as the CFTC voted to apply position limits to other markets in order to comply with the Dodd-Frank financial overhaul, they also approved a pending CME Group <CME.O> request to increase the limits substantially in grain markets. The new limits will widen to 12,000 contracts at each wheat exchange, whether in the spot month or all months combined; previously the limit was 5,000 contracts in a single month, or 6,500 contracts for all months. Uncertainty about exactly how the two Deutsche Bank funds will respond has kept traders on edge. "They still have sizable July positions in Minneapolis -are they going to keep them in Minneapolis, are they going to roll them? Are they going to bail out all in one day, or a long period of time? Or are they going to just let additional inflows of capital into the fund go into Chicago? There is a lot of confusion," said Helen Pound, senior analyst with Penson Futures in Minneapolis. Both the PowerShares DB Agriculture Fund <DBA> and the PowerShares DB Commodity Index Tracking Fund <DBC> ran afoul of the legacy limits in 2009, when the CFTC withdrew so-called no-action letters that had exempted the DB funds from speculative position limits for wheat, corn and soy futures. As a result, the funds abandoned their original indexes and began tracking much more diversified baskets in order to dilute the concentration on CBOT wheat and corn and pull their positions back to within the limits. The basis for the DBA is an index now called the DBIQ Diversified Agriculture Index Excess Return, which splits its wheat holdings between the CBOT contract and the Kansas City Board of Trade (KCBT), with 6.25 percent of each. But the funds also went a step further, splitting the proportion earmarked for "wheat" into both CBOT and Minneapolis contracts, a fact they didn't advertise widely but which is evident in their SEC filings since late 2009. The two contracts now comprise about 3 percent each of both indices. Although the MGEX contract is not an explicit part of the underlying benchmark index, the fund explained in a 2009 SEC filing that it had some discretion to invest in additional markets if necessary to track the index components: "The Index...includes additional Index Commodities that are not currently part of the DBLCI-OY Agriculture ER in order to permit the Fund to continue its objective of tracking an Index designed to reflect the performance of the agriculture sector and to facilitate and ensure future compliance with speculative position limits." (Link to SEC disclosure: http://sec.gov/Archives/edgar/data/1367305/000119312509201144/d8k.htm) LIMITS OR TRADE STRATEGY? While the move into Minneapolis may have been necessitated

by the position limits, some traders say there are sound reasons for the funds to hold on rather than liquidate. For one thing, the Chicago market is in contango, the back contracts trading at a higher price than nearbys, which means the fund theoretically loses money each time it rolls its positions forward. By contrast, the Minneapolis wheat market is inverted, making the fund roll profitable. Other traders speculate that the shift into Minneapolis may have been inspired as much by changes to the CBOT wheat storage scheme as by the regulatory environment. The 2010 launch of variable storage rates, or VSR, created wide carries between CBOT wheat futures contracts, keeping that market in contango. "The shift to MGEX and KCBT took place when the VSR started distorting the CBOT wheat spreads. It seems to be an economics play, more so than a position limit play," the trader said. However, CBOT wheat remains a far more liquid market than Minneapolis, a key attraction for funds. Open interest in CBOT wheat is roughly 390,000 contracts, about 10 times the open interest in MGEX wheat. "In an inverted market, (index funds) make more money, sure. But they want to be in the Chicago market. Liquidity, that's the big one," Huckabay said. FUND HOLDINGS IN MGEX WHEAT The latest fund data suggests that PowerShares' two funds, combined, are effectively maxed out on their CBOT holdings under the legacy trading limits, according to Reuters calculations. Lipper data showed total net assets for the PowerShares DB Agriculture Fund at $2.212 billion as of Nov. 30, 2011. The DBA fund's website said that as of Jan. 5, 2.9 percent of its holdings were invested in MGEX wheat, primarily in the July 2012 contract <MWEN2>. The fund weightings showed another 3.38 percent in CBOT wheat, mostly in July 2012 <WN2>. (Another 6.16 percent is in KCBT July wheat <KWN2>.) The DBA fund has additional holdings in other agricultural commodities such as cattle, corn, soybeans and coffee. Dividing the fund's assets by its weightings, the data suggests the DBA fund holds roughly 1,500 contracts of MGEX wheat and 2,400 contracts of CBOT wheat, according to Reuters calculations. (Another 4,000 contracts are in KCBT wheat.) For the PowerShares DB Commodity Index Tracking Fund <DBC>, Lipper data shows total net assets by Nov. 30 at $5.528 billion. The DBC fund's website reported its weightings as of Jan. 5 at 2.75 percent in MGEX wheat and 2.62 in CBOT wheat, primarily in the July 2012 contracts at both exchanges. The fund's holdings include grains as well as energies and metals. Roughly translated, the data indicates the DBC fund holds about 3,700 contracts in MGEX wheat and 4,600 contracts of CBOT wheat. (Reporting by Julie Ingwersen; Editing by Bob Burgdorfer and Lisa Shumaker) ((julie.ingwersen@thomsonreuters.com; +1 312-408-8720; Reuters Messaging: julie.ingwersen.reuters.com@reuters.net))