Today we have a look at US wheat prices, which have vastly underperformed soybeans and corn over the last few months and whether it is time for wheat prices to shine, absolutely and/or relatively.
The huge rallies in grain prices over the last year or so have caught plenty of attention, not only from farmers and commodities traders, but also geopolitically, as some blame the spike in food prices for providing a critical trigger in popular sentiment feeding into the unrest and revolutions across the Middle East and North Africa. Of the three main grains (soy, corn and wheat) wheat prices have rallied the least over the last several months - even if wheat prices are relatively expensive versus historic norms. That's more than a bit surprising, after last year's terrible heat wave in Russia disrupted production there, China has had issues with its wheat crop and now Australia's wheat crop is once again challenged by dry weather. And the biggest supply pinch yet may be on the way in the US, which is the world's largest exporter.
So why the wheat underperformance? Here a number of factors that look at why wheat is priced where it is and a few factors that are supportive of upside for wheat prices (at least the fundamental reasons - there is a financial market component to commodities these days that was less present not so many years ago. The entire Fed money printing/commodity rally theme of late is a huge background phenomenon that could easily prove as influential as the fundamental situation we discuss here.), both in absolute terms or in comparison with the other major grains, particularly corn:
Why wheat is relatively cheap:
"Wheat" in this case means CBOT wheat, which is soft red winter wheat - the hard red winter wheat traded in Kansas city is the one most affected by poor US conditions we discuss below and is trading at a historic premium to CBOT wheat. (As usual, agricultural commodity fundamentals prove themselves surprisingly complex). The soft red winter wheat crop condition is far better, though there are reports of slow plantings of spring wheat.
- Global grain stocks - global grain stocks are very low in general - but corn stocks are almost desperate, at a mere few weeks of supply. So the near record price of corn relative to wheat (See chart below.) makes sense given current supply conditions up to this point, the question now being how those supply conditions change and whether relative price becomes a factor, which leads us to:
"Wheat" in this case means CBOT wheat, which is soft red winter wheat - the hard red winter wheat traded in Kansas city is the one most affected by poor US conditions we discuss below and is trading at a historic premium to CBOT wheat. (As usual, agricultural commodity fundamentals prove themselves surprisingly complex). The soft red winter wheat crop condition is far better, though there are reports of slow plantings of spring wheat.
- Global grain stocks - global grain stocks are very low in general - but corn stocks are almost desperate, at a mere few weeks of supply. So the near record price of corn relative to wheat (See chart below.) makes sense given current supply conditions up to this point, the question now being how those supply conditions change and whether relative price becomes a factor, which leads us to:
Supportive for the absolute and relative price of wheat:
- Feed/food switching. For some uses, particularly animal feeds, the grains are relatively interchangeable and historic spreads between the grains are normally relatively stable within a certain range because of this, with the premium of soybeans over wheat and wheat over corn having largely to do with the relative protein content of the grains (soybeans have the most protein so they are the most expensive per pound historically). At current prices, there are tremendous incentives for those who can switch to wheat from corn in particular to do so. Relative soybean prices are near the tops of historic ranges as well.
- Global crop condition and weather. The USA is the largest exporter of wheat. The latest US crop condition reports for winter wheat are downright awful, with 38% of the crop considered in poor or very poor condition, versus 6% this time last year. And spring plantings are proceeding very slowly. Other areas of the world are also challenged, including slow winter wheat plantings in Europe last year and current weather challenges in Australia and North Africa. Further weather disruptiongs could kick a new wheat rally into high gear.
- Feed/food switching. For some uses, particularly animal feeds, the grains are relatively interchangeable and historic spreads between the grains are normally relatively stable within a certain range because of this, with the premium of soybeans over wheat and wheat over corn having largely to do with the relative protein content of the grains (soybeans have the most protein so they are the most expensive per pound historically). At current prices, there are tremendous incentives for those who can switch to wheat from corn in particular to do so. Relative soybean prices are near the tops of historic ranges as well.
- Global crop condition and weather. The USA is the largest exporter of wheat. The latest US crop condition reports for winter wheat are downright awful, with 38% of the crop considered in poor or very poor condition, versus 6% this time last year. And spring plantings are proceeding very slowly. Other areas of the world are also challenged, including slow winter wheat plantings in Europe last year and current weather challenges in Australia and North Africa. Further weather disruptiongs could kick a new wheat rally into high gear.
It's important to note that the market is already pricing in that the premium for wheat versus corn will revert to its normal range well ahead of year end, but weather will be a critical factor in determining when this inevitable reversion takes place.
Charts
The following sequence of three charts shows why crop conditions are so terrible in key growing areas for winter wheat in the US:
The following sequence of three charts shows why crop conditions are so terrible in key growing areas for winter wheat in the US:
Chart: US Drought Conditions
Drought conditions in the US show the extreme drought taking place in Texas and severe droughts taking place up into Kansas as well. The conditions are considered the worst since the early 1920's "dustbowl" drought: (source http://www.drought.unl.edu/dm/monitor.html)
Drought conditions in the US show the extreme drought taking place in Texas and severe droughts taking place up into Kansas as well. The conditions are considered the worst since the early 1920's "dustbowl" drought: (source http://www.drought.unl.edu/dm/monitor.html)
Chart: US Winter Wheat plantings
The chart above shows the areas of the US with the largest winter wheat plantings. (Source: http://www.nass.usda.gov/Charts_and_Maps/Crops_County/ww-pl.asp)
The chart above shows the areas of the US with the largest winter wheat plantings. (Source: http://www.nass.usda.gov/Charts_and_Maps/Crops_County/ww-pl.asp)
Chart: Overlay of winter wheat/drought areas
The chart below overlays the largest winter wheat planting areas (drawn around winter wheat planting chart above) on top of the drought monitor, showing why so much of the winter wheat crop is stressed in the US. For now, the Chicago soft winter wheat contract has escaped much of the spillover from the stress to the hard red winter wheat growing conditions - but could demand spillover from scant hard wheat and corn supplies and a pinched wheat supply elsewhere in the world feed into higher demand for CBOT wheat?
The chart below overlays the largest winter wheat planting areas (drawn around winter wheat planting chart above) on top of the drought monitor, showing why so much of the winter wheat crop is stressed in the US. For now, the Chicago soft winter wheat contract has escaped much of the spillover from the stress to the hard red winter wheat growing conditions - but could demand spillover from scant hard wheat and corn supplies and a pinched wheat supply elsewhere in the world feed into higher demand for CBOT wheat?
Chart: Wheat/Corn spread
The relative supply conditions have seen CBOT corn rally to record highs versus the CBOT wheat contract, with the front month reaching parity recently as shown above in the weekly chart. From here on out, weather will be a key factor in determining whether this spread can go even further in favor of corn or whether the high corn prices will erode relative demand for corn as buyers switch to wheat (and/or whether further fears of weather disruptions further aggravate the supply fundamentals for wheat as well). (Data source: Bloomberg)
The relative supply conditions have seen CBOT corn rally to record highs versus the CBOT wheat contract, with the front month reaching parity recently as shown above in the weekly chart. From here on out, weather will be a key factor in determining whether this spread can go even further in favor of corn or whether the high corn prices will erode relative demand for corn as buyers switch to wheat (and/or whether further fears of weather disruptions further aggravate the supply fundamentals for wheat as well). (Data source: Bloomberg)
Chart: July and December Wheat/Corn spreads
The July Wheat/Corn spread has bounced a bit here. By December (as shown in the December spread, which is well above $2 per bushel), the market is already pricing in that the price relationship of the two grains will revert back to its historical range meaning a relatively small window for those who believe the relative price for the two commodities will revert in the near term. Note that the spread of spreads (December spread less July spread) has contracted a bit forcefully of late and is yet another way to look at how the market perceives the relative timing of when the imbalance in corn vs. wheat prices will balance out. (Data source: Bloomberg)
The July Wheat/Corn spread has bounced a bit here. By December (as shown in the December spread, which is well above $2 per bushel), the market is already pricing in that the price relationship of the two grains will revert back to its historical range meaning a relatively small window for those who believe the relative price for the two commodities will revert in the near term. Note that the spread of spreads (December spread less July spread) has contracted a bit forcefully of late and is yet another way to look at how the market perceives the relative timing of when the imbalance in corn vs. wheat prices will balance out. (Data source: Bloomberg)
We end this report with a tongue twister of a questions: Whither wheat prices as weather withers wheat supplies?
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