Bellwether week for wheat

With the wheat harvest moving into the better production regions of Europe, the week ahead is likely to be defining for the future direction of prices. With prices building in a large risk premium to account for European production woes, the market is now looking for confirmation through harvest results.

Towards the end of last week we heard reports that western European harvest results were not as bad as expected. The impact on prices though was offset by ongoing hot and dry weather in Russia and Kazakhstan that was thought to be dragging on yield prospects there.

But the wheat market is well equipped to deal with some production issues. After back-to-back record global wheat crops that had rebuilt stocks, production problems across the US and Europe will see wheat reserves fall around 10% this year to 175mmt or a stocks to use ratio of 25%.

A bull market normally wouldn’t develop until stocks to use tighten to below 20%. So, on the basis of current information, the pre-conditions for an extended wheat market rally don’t appear to exist. But the market is smart so you need to ask yourself what is it seeing that I can’t?

It could be that the Canadian or European production situation is worse than anticipated. Or the market may be concerned that the corn balance is tightening again (remember this was the catalyst for the massive rally in 2007/08). But wheat has already moved back to a traditionally large premium over corn and if corn chases wheat higher it will cause damage to demand. Whatever the case, we will get more clarity on these issues in the next month or so.

Whenever I feel there are illogical inconsistencies between price movements and fundamentals, I firstly question whether the basis of my assumptions are correct, I then look at what the funds are doing.

While I don’t believe the speculative funds control market direction (we would be mostly likely still heading down without the Canadian and European production problems), they can certainly amplify market movements. Over the past month the spec funds have been pushed out of their wheat market short and this I believe has been the major reason for the run up in values over the past month.

Market in Euphoric mood

Last week I read in an international new wire ‘Australian wheat farmers are contending with a plague of locusts’. This was just one of the reasons used to explain the rally in grain prices over the past month.

While the locusts may become an issue for this crop down the track, it is drawing a long bow to tie this to the recent rally in international grain prices.

When you here this type of thing you get the feeling that something is not quite right. Make no mistake! The bulls have got hold of this market.

Analysts are searching far and wide for reasons to explain recent large price advances. Sure there have been some fundamental drivers (Canada, Europe, Russia, USDA revision to corn stocks and now hot weather in the US), but a large part of the gain seems to be linked to speculative fund shorts looking for a way out of wheat.

What would explain the fact that wheat has the most comfortable balance sheet of any of the grains, but is now leading the market higher? Since mid-June the wheat market has rallied 150USc/bu or 33%. Wheat stocks will fall in the coming year, with latest estimates that stocks will fall by 3% to be the second largest level since 2000/2001, hardly the justification for a 33% price rise?

Even if you wipe another 20mmt from wheat stocks (putting production losses at 2 times current estimates), wheat stocks to use would still be at a comfortable 25%.

One thing we have learned is not to get in the markets way when it is in this mood. Speculative traders who have been short this market may decide to change their view 360 degrees and take a long position. Meanwhile, ideas of record US corn yields seem to have gone by the by. With the recent tightening in the corn balance sheet, weather forecasts over the next month or so will be crucial in determining corn prices.

Expect grain prices to provide plenty of excitement over the next month or so as we head into spring.

Markets advance of European weather woes

International grains markets posted further good gains last week mainly on dryness across Europe, but also on concerns for US crop yields. The USDA global S&D report released on Friday night essentially confirmed traders thoughts that global coarse grain stocks are on the retreat and that strong US corn yields will be necessary to prevent further tightness.

On this, the outlook for US summer crop yields has turned lower in recent weeks. After traveling portions of the central and western Corn Belt, US ProFarmer crop consultant, Dr. Cordonnier sees the USDA eventually cutting its estimates of harvested corn and soybean acres from the June Acreage Report. He also lowered his national corn yield estimate last week to 161bu/ac, putting his corn crop peg at 12.99 billion bushels (2% lower than USDA’s estimate of 13.245 billion bu).

Ideas of sliding US corn yields are menacing given that the USDA has just made a sizable reduction to global coarse grain stocks and yields given recent production issues in Canada, China and Europe.

Dr. Cordonnier also dropped his US soybean yield estimate to 41bu/ac and his bean crop estimate to 3.17 billion bushels (vs USDA at 3.345 billion bushels). Ideas on US soybean yields are being curtailed at the same time Canada is confirming weaker canola production. Late last week Agriculture Canada put the 2010 Canadian canola crop at 10.5mmt, down from 11.7mmt in its last update. With the weather in Europe also turning sour for yields, global oilseed production is under pressure as well.

The outlier to current trends in coarse grain and oilseeds is wheat. Despite the USDA reporting last Friday that US wheat stocks at the end of 2010/11 will be the highest since 1987, wheat prices gained another 7% last week riding on the coattails of higher corn and oilseed prices. Wheat is currently by far the weakest link in the grain chain. Unless harvest results in Europe confirm that yields have been damaged by the recent hot and dry weather, look for wheat values to ease vis-a-via other grains to attract feeding demand.

USDA Game Changer

In my 7 years of closely watching grain markets there have been maybe 3 or 4 reports that have changed consensus thinking: make no mistake USDA’s 30 June 2010 report was one of these.

Over the past couple of months we have been slowly watching grain market sentiment change. Dryness in China, the big wet in Canadian and now an early European spring have finally changed analysts views on the future direction of stocks (most are now expecting end stocks to fall by the end of 2010/11). But our optimism was being kept in check by strong prospects for the US corn crop.

Fast-forward to last week’s USDA report and the surprise 30 June corn stocks number. This was much lower than anyone had been expecting and meant that corn use in March-May was record large and 25% higher than the previous year.

The USDA use these stocks numbers to recalibrate their production numbers and many believe the lower stocks figure suggests the USDA have been overestimating the size of last year’s corn crop. You may recall us voicing doubts about the size of the 2009 US corn crop due to low test weights and poor grain quality.

So essentially the USDA report has wiped out a big chunk of available supply that everyone had factored into their calculation. The much lower stocks position will place increased pressure on the current US crop to come in with big yields (remembering that corn demand will rise again in 2010).

In our eyes the USDA has taken away the safety net under global coarse grain supplies. End users should become more inclined to buy now and ask questions later as another production issue could quickly tighten stocks to uncomfortable levels.

With the stocks buffer being taken away, markets will now be much more sensitive to developing production issues such as dryness across Western Australia and anything that threatens US corn crop yields.

Expect volatility to increase over the next few months as northern hemisphere yields are made and as southern hemisphere crops enter spring. We are targeting >A$240/t wheat prices and feed barley values >A$220/t, but won’t be willing to take on much production risk to achieve these. We were looking for something to finally sway grain market sentiment and in last week’s USDA report we may have got it.

Some better signs

While the rally in canola has stalled somewhat, there are some better longer-term signs emerging for world grains markets on the prospects for significantly lower Canadian production.

Already there was some expectation that barley and wheat would ease this year as lower plantings and a return to average yields would see production levels decrease from the peak levels of the past couple of years.

This combined with the Canadian situation will see some grain take a bite out of heavy stocks levels this year. This will be particularly the case for grains where Canadian production is predominant: durum wheat, higher protein spring wheat, barley, canola and pulses.

The barley situation bears watching as we continue to hear reports of crop problems in the EU. On top of this EU feed barley has been the focus of market's attention of late with reports that China purchased up to four Panamax vessels of EU feed barley.

With the Euro easing and a lower import tax on barley than corn in China, EU barley is now competitively priced against imported corn by around US$20/t on a CIF basis.

The high cost of domestic corn is also a factor that has made feed barley imports attractive to feed compounders. The EU is in a strong position to meet demand for shipments this year as Australia is almost sold out of old crop and in view of the crop situation, Canada is out of the market. Black Sea exports are banned from China, due to strict import protocols.

The elephant in the room that is anchoring coarse grain prices at the moment is an expected record large US corn crop. However, if something goes wrong with this crop, there could be a scramble on to secure future supplies. In light of this, the risk/reward matrix dictates that we continue to hold on forward selling barley.

Time to pull the trigger on canola

There are strong signals that the canola market may be topping out. For those who haven't made use of the rally to hedge forward production, now is the time. Earlier last week we made a recommendation to hedge 15% of expected canola production.

The market has moved higher since then on longer-term forecasts calling for more wet weather in Canada - which may affect yield potential on canola crops already on the ground. We are advising to take advantage of this and make a further 15% forward sale.

Canola has now pushed to a US$76/t premium to beans, its highest in two years and back to the high end of the range (excluding the 2008 period when canola briefly shot well into the 100/t’s above beans).

Canola board crush margins have dropped $50/t in a week (the lowest in 2 years) and Canadian canola is trading a premium to EU rapeseed, which is very unusual.

These all suggest canola is doing (or has probably already done) a great job in rationing demand even with a 10-11mmt Canadian crop (they had been expecting +13mmt on large plantings).

On top of this, there are reports that the European rapeseed crop won’t reach earlier potential.

Nonetheless, canola is part of the global oilseed complex and cannot escape the fact that potential price upside will be limited to the prices of other vegetable oils (due to the high degree of substitutability between veg oils). The US soybean crop is in excellent condition and there are still plenty of soybeans available in Sth America.

Short-term short covering might see some further upside, but really it seems that once that is done, in order to sustain the rally we need to see something from beans and/or grains (which appears unlikely given strong US growing season conditions).

Canola, hard wheat on the way up

The big news in the past week has been wet weather in Canada that is threatening to prevent some 15-25% of its cropping area from being planted this season.

Canada had a very dry winter and early spring, however, in the past month, many Canadian cropping areas have received 200-300% of their normal rainfall. The excessive moisture has resulted in the slowest planting pace in recent history and an expectation for the largest abandoned acreage in Western Canada since Government programs in the early 1970's intentionally idled acreage.

In an industry briefing last week, the Canadian Wheat Board (CWB) said that exceptional spring rainfall will severely impact 2010 crop production and projects anywhere from 8 to 12 million Prairie acres will be left unplanted this year.

Of this total, 3 million acres will likely be wheat, 1.6 million barley and 5.4 million of other crops (mostly canola, but also oats and peas). On top of this, there will also be lost production from crops suffering under excess moisture conditions. The CWB is estimating wheat and barley production

Canada dominates global canola exports and, therefore, canola prices have responded sharply, moving to a wider price premium over soybeans (back to 20%). The price premium has been tight (neutral up to 6-8%) to encourage increased exports after China imposed export restrictions on canola late last year.

Canola prices have a little more room to run, however, they will be capped by strong soybean production potential out of the US. Last week, the USDA said 85% of the US soybean crop was in good/excellent condition – you don’t get much better than this. Apart from a small amount of labeled product demand, vegetable oils are highly substitutable and demand for canola will ease sharply if prices move out of whack with the rest of the global oilseed complex.

Hard wheat should also benefit from the problems in Canada. Canada is a significant producer of higher protein wheat and is the latest in a list of global hard wheat producers to suffer production and quality issues. Early harvest results suggest the US Hard Red Winter (HRW) crop is low in protein, whilst cool, soft growing season conditions do not augur well for the US spring wheat crop (which is normally high protein).

In Australia, some of our best producing hard wheat country – in southern QLD - has not yet been planted. These events should soon start to widen the premium good quality, high protein wheat holds over other wheat.