Monday, July 26, 2010

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.

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