What now for new crop wheat?

New season wheat prices continue to offer attractive levels at $331/t (FIS Kwinana). As of December 1st, APW2 new season prices have averaged $333/t, after reaching a peak of $360/t in 14/15 February. Traditionally the February – April window offers the best returns for growers who wish to forward sell, and this year is no inception.

New season wheat basis levels (currently at +$A23/t over CME Dec futures) are following a typical pattern in a normal year. Basis levels start the year low, then fall at harvest before recovering in the post harvest period. This low basis early in the year is what makes fixed price forward contracts uncompetitive against forward selling with swaps. We have highlighted this over the past couple of weeks when swaps were trading at a $50/t premium over fixed grade contracts.

Targeting sales when basis levels are high can be a way of adding an extra premium to prices at already high deciles levels.

This time of year the international grain and oilseeds market tends to shift its focus from demand to weather, and this is definitely one of those years. Indeed, weather has been an issue since last Oct/Nov in the US when much of the western central and southern plains winter wheat was planted into very dry conditions, germination and emergence was paltry at best and winter offered no relief from the harsh conditions.

For most regions, the growing season is just beginning and weather is already a huge factor. If the rains do not materialise soon for the western US plains, wheat could easily have more rally power in it. Four of the top five producing Hard Red Winter states are reporting conditions that are 50% Poor-to-Very Poor! The seasonal tendency is for wheat to build a weather premium through much of April. I think it’s worth noting that some of that usual weather premium includes frost, which hasn’t even been mentioned yet.

Markets this week will be closely monitoring the USDA acreage report that is due Friday morning. This will give the market its first glance at what US farmers intend to plant, and what future price direction for most agriculture commodities will likely to be. With high prices not dampening export demand and tight US stocks, it will give the market what commodity prices need to do (either move higher or lower) to capture more acreage. Early indication corn will be the most dominate crop (most profitable) followed by a loss of soybean acres. Expect winter wheat acreage to be ploughed up and re-sown to corn.

The reality is that with prices again nudging $330/t decile 9.5 (that is over the preceding 10 year prices have spent 95% of the time at or below this price), this represents a good price to start hedging. Internationally there are many factors that could markets go higher in the short term (US spring time), but don’t set too aggressive forward price targets.

Potential Japanese Nuclear fallout sends market into free fall.

Nuclear melt down in Japan? Although another Chernobyl is unlikely (were wheat gained 19% over ten trading sessions in 1986), the implications will be catastrophic on an economy already on its knees and a world economy still emerging from the GFC.

The 9.0 magnitude earthquake and tsunami that struck Japan last Friday afternoon has left world markets reeling, with commodities, stocks and treasuries not immune to the liquidation. The Japanese PM describes the aftermath as the worst crisis since WW2, with the death toll projected in the tens of thousands. The developing situation has made the markets nervous, especially in regard to fears of radioactive release from damaged power reactors north of Tokyo.

This uncertainty about the global economy and health of the Japanese economy is currently bearing heavily on the market (with grain markets all limit down last night), with thoughts that Japanese demand for commodities will drop and investor’s appetitive for risk disappearing.

Although the full extent of damage is yet to be determined, impact on ports and road infrastructure will be crucial to grain imports. With reports filtering through that key grain ports, which are located along the west coast and further south of the epicenter have no major structural damage evident.

With Japan a big customer of agricultural products, the third largest buyer of Australian wheat (1.1mmt in 2009/10) and a large purchaser of North American corn, wheat and canola. What are the impacts? So far none, with a Japanese colleague saying that no grain cargoes bound for Japan have been diverted or canceled as yet.

The situation shouldn’t pose a serious long-term issue with grain supply; the government will be looking to quell any future negative impact and will insure the quick flow of imported food. What should be looked closely is the risk of nuclear meltdown, with a fourth explosion in four days on the Fukushima Dai-ichi plant. If the worse case scenario happens, the nuclear fallout (depending on wind) will be catastrophic in one of the world’s densely populated areas.

This knee jerk reaction of the grain markets seems a bit over the top, considering no export business is lost (still tendering for grain in fact) and no major grain discharge terminal have minimal damage. However massive speculative selling and subsequent volatility reigns supreme. But as we learned in Economics, “cool heads should prevail and it never pays to sell in a market that is in free fall”

No surprises in this month USDA Report

The USDA released their latest Agriculture Supply and Demand Estimates report overnight. World feed grain stocks have been raised slightly as lower use more than offsets lower production. Despite the slight revision, feed grain supplies are in-line with historically low 2006/07 levels. US corn stocks were left unchanged at an extraordinarily tight 17 mmt.

World wheat inventories for 2010/11 were raised by 4 mmt (Australia crop +1mmt to 26mmt) to 182 mmt, reflecting lower consumption (in both the livestock feed and human food categories) and increased production in the southern hemisphere. The global stock-to-use ratio, at 27.4%, indicates old-crop wheat supplies are not short. The USDA lowered its import estimates for the Middle-East & North Africa region.

US wheat stocks have been increased this month because of lower exports. This was probably the only real surprise form the report, as it was first thought that exports were at a cracking pace. US exports have been reduced by 680,000/t, with stocks increased by this margin to 23mmt (34% stock-to-use ratio). In 2007/08, US stocks fell to 8.3mmt (13%), therefore, from a relative perspective, current supplies are ample.

World soybean and oilseed stocks were lifted slightly this month. A larger soybean crop for Brazil, up 1.5 mmt (record 70mmt), was largely offset by an increase in use and beginning stocks. Chinese soybean import estimates were raised. US soybean stocks were left unchanged at a tight 140 million bushels.

This report, as expected didn’t fire many shots in reviewing old crop stocks. The anticipation is building for the first big report for the year, the USDA Prospective Planting Report on the 31st March. This will give the market some indication if the previous rally in prices “bought” enough acres for spring plating.

ABARES grain & oilseeds forecasts for the new season.

Australian Bureau of Agricultural and Resource Economic and Sciences (ABARES) released the latest March quarter report. This report covers a diverse range of forecasts and trends for commodities. Several key points from the report are: ~

Despite the recent adverse weather impacts, the value of farm exports (grain, oilseeds, rice, cotton, sugar, wool, wine and meat) is forecast to rise by around 4.4% to $32.5 billion in 2011-12. Wheat is ranked 9th in terms of export value ($5 billion) for the 2010/11 market year a long way behind iron ore at $56.5b.

The Aussie dollar is assumed to remain relatively strong on the back of high interest rates and strong mineral exports. In the next few years (2012-13) it will average around US 97c, before moderating gradually to average US90c 2015-16.

The 2011/12 wheat area is forecast to increase by 3% to 13.8 million hectares. Despite the increase in area, wheat production in 2011–12 is forecast to be around 24 mmt as a result of an assumed decline in yields from this years bumper harvest. Wheat exports in 2011–12 are forecast to be around 16.5 mmt. Barley is forecast to fall another 3% to just under 4 million hectares. The grower’s reluctance to switch to alternative crops that provide better cash flow is clearly evident with the smallest barley area for nine years!

ABARES pegged Australian wheat exports for 2011/12 at 16.5 MMT, up slightly from their 2010/11 estimate of 16.2 MMT.

With such high soil moisture across eastern Australia, canola is to increase by 6%, reflecting favourable prices and strong global demand for oilseeds. Production is forecast to be around 2.2 mmt, 4% higher than last season, reflecting a larger area and a return to average yields, particularly in Western Australia after drought last season.

Grain prices are projected to decline gradually from current highs, but to remain above long-term averages. Factors expected to support world grain prices over this period include continued income and population growth in key import markets, which will lead to higher demand for feed grains and protein meal, and for industrial use, such as biofuels production.

High volatility in the market as Hedge funds liquidate positions.

Last weeks liquidation of US agricultural futures is a testament how much influence hedge funds have on the market, and how speculative volume has increased. Figures released from the Commodity Futures Trading Commission, indicating that speculators reduced bets on rising wheat prices by 57% last week, the biggest drop since November. Bullish bets on soybeans fell 17%, declining for a third straight week, and those for corn slid 1.8% to a seven-week low. Although fundamentally little has changed (especially in the white hot corn market), it should be taken as a warning that the preceding seven month bull run may be running out of steam. 

With civil unrest in the Middle East and North Africa threatening to curtail economic recovery, speculative money flowed out of ‘riskier’ agricultural futures and into crude oil and gold. Then last Friday we saw funds re-emerge and buy back previously sold positions, making it one off our most volatile weeks of the year and first major correction since December. 

During the preceding six months, Barclays Capital has estimated that $2.6 billion has flowed into agricultural derivatives, after a record $5.7 billion during the fourth quarter of 2010. And so when hedge funds hold these very large net long positions, and suddenly exit the market, the price moves are magnified and the end result is limit down fluctuations. There are many diverse cashed up hedge funds looking to spread their investment portfolio, and for a small fraction of them to be convinced to own some commodities, is creates new demand and thus greater volume.

The days are long gone when you can simply focus on supply and demand, now traders & growers alike must keep track of the world political situation that threatens world economic growth, world currency, interest rates and ethanol mandate levels (an industry that consumes 40% of US corn), all while trying to gauge investor’s appetite for risk. As a result, it is becoming a delicate balancing act in the grains market and that's creating extreme price volatility.

Although there was a short term sell off last week; the true fundamentals remain strong going into 2011. While excess volatility presenting potentially historic pricing opportunities, it also increases the large swings in daily prices that we have witnessed. As a result basic supply/demand fundamentals must remain the basis for making long-term marketing decisions. Expect March to have increased buying volume, as is usually a buying month for funds as they add ‘long's’ for the uncertainty of the Northern Hampshire spring planting and growing season.