When the market is bombarding us with noise, sometimes it pays to put in a set of earplugs and take a few minutes to look at one or two essential pictures that provide a better illustration of the bigger story.
Grain markets are volatile, particularly during the growing season as traders try to figure out what the size of the crop will be the number ebbs and flows with every change in the forecast. This year has been unusually erratic as the demand side of the equation is further thrown into turmoil with the many trade disputes going through iterations of pessimism and optimism.
Wheat may be just as volatile, or more so than any other major market. This summer has proven to be the case again with the Kansas City hard red winter wheat December contract hitting as low as $4.94 per bush on July 2, rallying over 25 per cent in barely over a month up to $6.26 on August 7, and then dropping entirely a $1 per bushel in the ensuing three weeks. It’s true there was some shifting of the perception of the critical Northern Hemisphere crop during that time, but the reality is also that by the time July hits, the market has a pretty good sense of what the final production will likely be.
So why all of the volatility, and what is the actual ‘fair’ value for wheat?
Aside from some modest shifting of the fundamentals, much of what we have experienced over the past month has primarily been ‘noise.’ The market rallied hard on slipping crop conditions through many key regions, including Europe, Russia, and the Canadian Prairies. While the feeling is that things may not end up being quite as bad as they appeared when the market peaked in early August, there certainly wasn’t the kind of dramatic improvement that would warrant prices giving up most of their gains in just a few short weeks.
Instead, prices put too much weight on the somewhat negative factors that focused more on the shorter term picture (increasing U.S. corn yields, speculative funds having placed large bullish bets in the wheat market, and an August USDA report that didn’t capture the full extent of declining production prospects in some key growing regions).
It can be challenging to try and determine what is essential when sifting through all the day-to-day market chatter. In these instances, it helps to focus on one or two critical underlying fundamental variables. In the case of wheat, perhaps the most significant dynamic that should drive wheat prices over the coming months is the fact that stocks are expected to drop sharply across the major exporting countries. In fact, when stripping out the U.S., the decline is quite dramatic (see chart below of projected ending stocks for the non-U.S. major wheat exporting countries).
Does this mean that wheat prices will inevitably explode higher overnight? Not necessarily – as several moving parts may require some time to play out. This includes the fact that the Black Sea countries remain aggressive exporters early in the season even if their stocks are down from last year, the U.S. itself has ample wheat supplies, and there is a lot of negative sentiment that spills over from a heavy corn and soybean market. Nonetheless, what the graph shows is that supplies have dwindled in the key suppliers. Global buyers will have little choice but to come to the U.S. and Canada in a more meaningful way to get their necessary wheat supplies in the second half of the crop year, something that will be even more pronounced given the drought-reduced wheat crop in Australia. It may also be that the price response shows up more in cash basis levels and futures spreads than a raging futures bull market. But the longer term trajectory is supportive of the price levels we see today.