Friday, May 21, 2010

Collapse in spread the right medicine

The wheat market is sick. At the end of this year, the wheat stocks to use ratio is forecast to be around 30%. In the old days, the stocks to use rule of thumb was that anything under 20% was considered bullish for prices and anything over 30% was considered bearish. In reality, with improvements in global trade and logistics, this peg has probably moved down a few percentage points.

Anyway you look at it, the wheat market is sick and needs some quick medicine to get it better. Last week, traders prescribed some medicine, slashing global wheat values by 30USc/bu or around 6%. The aim being to make wheat more competitive with corn and encourage increased wheat demand (as feeders witch from corn to wheat).

Another way for wheat to become more competitive - from a feeding perspective - is for corn prices to rise. China announced further purchases of US corn last week to bring the total of reported sales so far this year to nearly 500,000t. The threat of imports has so far failed to bring down Chinese corn prices. Analysts are now forecasting that Chinese corn imports from the US could be between 1-6mmt this year.

The impact of Chinese corn imports is two-fold. The first is psychological. Anyone short of corn (from end users to funds who expect prices to continue decreasing) start to become nervous, question their market view and possibly reverse their positions. Secondly, Chinese corn imports will tighten the corn balance sheet (currently 2010/11 end stocks to use are forecast at around 18%), reduce the margin of error for 2010/11 crops. Corn prices held last week, despite heavy pressure from outside markets (stronger $US, lower crude oil prices and global growth concerns).

Our thinking is that with strong prospects for another massive US corn crop, corn fundamentals alone will not be enough to sustain higher corn values, notwithstanding larger than expected Chinese corn imports. If Chinese coarse grain buying changes grain market psychology, and leads grain prices spiking higher, we will take this opportunity to commence hedging.

Last week’s action has dramatically altered the wheat/corn spread. The Chicago Board of Trade (CBOT) futures spread collapsed by 22% in just the one week and is now threatening long-term support just above 100USc/bu. In parts of the US (Texas/Oklahoma) wheat is now trading on a par with corn in physical cash grain markets. The narrowing in this spread is the market trying to heal the wheat supply imbalance. The medicine may not taste to good, but should lead to a quick and full recovery.

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