Joe Victor, Business Development Specialist, Minneapolis Grain Exchange
The price of wheat futures at the Minneapolis Grain Exchange, Inc. (MGEX), Kansas City Board of Trade (KCBT) and CME Group experienced a wild ride over the past year, and the increased level of volatility looks like it will continue in 2011. Last year, Russia fueled wheat prices by announcing that they would limit wheat exports and this year traders are already speculating on the impact of the devastating earthquake and tsunami in Japan. As Japan is the largest importer of corn and the fourth largest importer of wheat in the world, a slowdown in their demand could have a significant impact on global commodity prices and continue to drive up volatility.
Global Wheat Supply
In July 2010, Russia announced that drought and wildfires would severely limit wheat exports and the prices soared in the ensuing weeks. A few years earlier, in 2006, Russia proclaimed it would be the world’s largest grain exporter. Droughts affected the entire Black Sea region, which includes Russia, Ukraine, Kazakhstan, and parts of Western Europe. The Black Sea region proved to be a strong export market from 2007-2008 through the 2009-2010 market years. However, the Russian export bottom fell out in the 2010-2011 market year because of the aforementioned drought, and Russia’s export program finished poorly. It is anticipated Russia will be a top supplier in 2011, especially for North Africa, the Middle East and Asia.
The pressure to obtain quality wheat was further exacerbated by persistent rains in eastern Australia, causing the downgrade of milling wheat to feed wheat. At least thirty percent of the eastern Australian wheat crop is now classified as feed wheat. Australia is the world’s fourth-largest wheat exporter and is an integral player of supplying the world with high quality wheat.
This downgrade of Australian wheat caused China to cancel a 2 million metric tonnes Argentinean corn import. At the same time, China bought approximately 1 million metric tonnes of Australian feed wheat in an effort to save money on transportation. It was more important for China to readily obtain feed wheat more than to wait for the Argentina corn harvest. The beginning of 2011 was dominated by news about dry weather conditions in the key wheat growing region of China. There are two important issues when considering the drought in China. In 2006, the last time China experienced a drought, the country produced a record crop. Secondly, according the USDA, China currently holds 33.8 percent of the world end stocks of wheat, the largest amount by any individual country. According to China, they have 100 million tonnes of wheat and are expected to consume 108.8 million tonnes in the 2010-2011 market year. Whichever number you focus on, USDA or China, China’s importance to the world wheat market is abundantly clear.
North American Wheat Production
Looking at North American wheat regions, the U.S. northern plains and Canada face the problem of potential springtime flooding which may force planting delays in spring wheat regions. Meanwhile, in Kansas there is concern about dry weather effecting hard red winter wheat harvests.
Fifty-one percent of the U.S. hard red winter wheat (HRWW) is grown in Kansas, Oklahoma, Texas, Colorado, and South Dakota. In terms of volume, it is the most produced wheat in the U.S. HRWW is a good protein wheat used primarily in breads and rolls. Sixty percent of total U.S. HRWW production is projected for exports this year, compared to 40 percent last year and a five year average of 45 percent.
Eighty-six percent of the U.S. spring wheat crop is grown in Minnesota, Montana, North Dakota and South Dakota. Hard red spring wheat (HRSW) is a high protein wheat used primarily for its milling and baking quality for bread. It is the second largest wheat class grown in the U.S. Sixty two percent of total U.S. HRSW production is destined for exports this year, versus 39 percent last year and a five year average of 53 percent.
Twenty-one percent of the U.S. soft red winter wheat (SRWW) is grown in Missouri, Arkansas, Tennessee, Kentucky, Illinois, Indiana, Ohio, Michigan and North Carolina. This is the third largest wheat class produced in the U.S. It is a low protein grain used for many snack foods such as crackers. Forty percent of total U.S. SRWW production is projected for exports this year, versus 27 percent last year and a five year average of 36 percent.
Global Wheat Supply & Demand
As you can see in the graph, the present day world supply of wheat, registered as 85 days, is down against last year’s supply and down by six days when compared to the previous 11-year average. The downward trend in all starches might suggest we are able to resolve the short term problem of tightness but not the long term one.
The five largest consumers of wheat are shown in Figure 3, including EU-27, China, India, Russia and the United States. Of the five, only the U.S. has a downward sloping linear trend-line. China’s demand remains steady, while all others have increased demand. It is possible that demand increase is one of the reasons why global seed companies are researching the use of genetically modified organisms, or GMO wheat.
Wheat Technicals and Spread Trading
The price chart in Figure 4 illustrates MGEX HRSW futures prices moving higher, holding trend line support from September 2010 through March 2011. We already know the Russian drought and Australian rains occurred during this time period, as did periods of consolidation. This same time period saw MGEX HRSW futures prices increase 63 percent, KCBT HRWW futures prices increase 60 percent and CBOT SRWW futures prices increase 36 percent.
At the end of March 2011, the USDA estimates increased plantings of spring wheat, corn, soybeans and a host of other crops. There is incentive to plant these major three crops as price ratios remain intact. Farmers, as well as their lenders, plan ahead when deciding crop rotation, dollars per acre, demographics and the final piece to this complex puzzle – weather.
The spread chart in Figure 5 represents the demand for high protein HRSW versus the lower protein based SRWW. This spread traded has added $1.00 above key resistance established June 21, 2010, and trend line support continues to hold since September 10, 2010.
Additionally, the spread trade of the high protein HRSW versus the HRWW shows trend line support since September 10, 2010. This may be due to the difference in protein levels for the various wheat contracts. What may be more of a challenge is spread trading the low protein SRWW versus corn, another low protein. There is a wide range of trade, and most importantly a lack of short and long term trend. Both SRWW and corn are high caloric items as opposed to high protein. It is possible to substitute one caloric item for another, such as feed wheat for corn, but it is not possible to substitute a high protein wheat for a caloric item.
A Look Ahead
Global high protein wheat demand remains strong with supply shortfalls occurring in 2010-2011 for Russia and Australia. Demand increases are apparent as nine of the top 10 countries that import U.S. wheat are receiving more this marketing year than in 2009-2010. Experience suggests there is little in the way of allegiance in the world, and countries may look for wheat elsewhere to help save on transportation. U.S. wheat quality remains suspect in the HRWW region, and flooding may be a problem in the Northern Plains. Canadian farmers are also anxiously waiting to turn their planting wheels. These weather issues are affecting the crop, yet futures trading remains strong. In addition, the impact of the earthquake in Japan on global wheat demand will only create increased uncertainty in the coming months.