It doesn't matter whom I talk to these days -- corn farmers from Nebraska, financial reporters from CNBC, Mark Pearson hosting IPTV's Market to Market program, etc. -- the topic soon turns to wheat. The theme of this column, "Wheat: Crazy From the Heat," personifies the explosive rally from late June through late July that has seen the September Chicago contract rally $2.00, more so than my second title choice of "Wheat: The Market that is Full of Hot Air."
The month-long rally in the wheat market may mean the futures market is losing touch with reality. (DTN photo by Susanne Stahl, chart by Darin Newsom)
Above-normal July temperatures in the major trading cities of New York, Chicago, Kansas City and Minneapolis may have played a role in one of the largest noncommercial buying sprees on record in wheat, with the combined net futures position (all three exchanges) moving from a net-short of 16,553 contracts as of June 29 to a net-long of 67,188 contracts as of July 20. And that isn't counting the possible addition of another 30,000 contracts through July 27 (these numbers won't be released until Friday afternoon).
How are the heat and the trade action related? Heat warps our ability to concentrate, meaning traders may not look past the headlines that have been screaming about the Eastern European drought and lost acres in Canada, ignoring the conclusion of most of the reports and articles that point out the global crop is still expected to be the third largest on record.
But, seriously, the bottom line is this: The general consensus seems to be a loss of another 15 million metric tons of production worldwide. Leaving the other supply and demand categories unchanged would put world ending stocks at 172 mmt, and the world ending stocks-to-use ratio at 26 percent. Putting that number in perspective: Over the last 10 years, the world ending stocks-to-use ratio has averaged 26 percent, while the mean cash price received by U.S. farmers has averaged $4.16. As of Thursday night, the three major DTN National Indexes for wheat (HRW, SRW and HRS) averaged about $5.47.
The argument is that tighter global supplies, coupled with the ongoing weakness of the U.S. dollar index, is going to lead to increased demand for U.S. wheat. I agree. Most likely USDA's July estimate of 1.0 billion bushels of export demand is going to grow, as well it should. Let's say the entire 15 mmt global loss (roughly 550 million bushels) moves to the U.S., increasing demand by a like amount. That would put U.S. ending stocks at approximately 543 mb and the ending stocks-to-use ratio at about 20 percent. Averaging the average cash price received for 2007-08 of $6.48 when the domestic ending stocks-to-use ratio was 13 percent and the 2005-06 average cash price of $3.42 (27 percent domestic ending stocks to use) results in a theoretical equivalent cash price expectation of $5.45.
So while the noncommercial side of the market continues its buying spree, the commercial side may be forced to shore up its defenses against the price onslaught by strengthening the carry in the futures spreads and weakening the basis. Even those market bulls who are reveling in the rally should see a problem. In a normal short-supply situation, the futures spreads normally see a sharp weakening of the carry, possibly even moving into a strong inverted situation. Also, commercial traders are forced to bid up the cash market, as opposed to bidding it down, leading to an abnormally strong basis market (cash price minus futures price) in an attempt to source enough supply to meet demand.
There is a possibility that some of my recent articles have led to the perception that I am against the surging wheat market. No, not really. While I don't think it is good for the market as a whole, coming from a wheat background, I don't mind that wheat farmers now have the opportunity to take advantage of a market in overdrive like other producers in other markets have been able to do in recent years.
The problem is recognizing this opportunity and using it to one's advantage. Winter wheat producers should be taking a look at the July 2011 and 2012 contracts in both Chicago and Kansas City and realize that these prices (near or above $7.00) are near the upper 20 percent of the price distribution range since the 2005-2006 marketing year. And simple reversion to the mean analysis would indicate that the markets should at least fall back to the midpoint of the range at $5.00 in Chicago and $5.18 in Kansas City once this rally comes to an end and the markets start to fall back in search of fundamental support.
Darin Newsom can be reached at darin.newsom@telventdtn.com
(SK/AG)
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