Tuesday, April 5, 2011

A Bullish Case for Wheat - Apr 5th

A Bullish Case for Wheat
April 5th, 2011

If asked only weeks ago, I would have said that the only thing the wheat market had going for it was the sky-high price of corn, since as corn gets more expensive relative to wheat, livestock farmers tend to switch feedstock, bidding up the price of wheat.  As it turns out, Mother Nature had her own plan for this year’s wheat crop. 

USDA Crop Conditions Report

Now that planting season is upon us, the USDA has begun its weekly release of crop conditions and planting progress reports, released each Monday at 4pm EST.  Yesterday’s was the first of the year, and it came as a surprise to most market participants.  The winter wheat crop was rated 37% good/excellent, down from 65% this week last year, and the lowest reading since 2002, which was the worst year on record.  On a similar note, the crop was rated 32% poor/very poor, again the worst year was in 2002 at 35%.  This could indicate poor yields this season, as in 2002 when farmers harvested 35 bushels per acre, as compared to 46.4 last year.  Dry weather in the Southern Plains is to blame.

A Primer on U.S. Wheat Markets

There are several types of wheat grown in the U.S., and there are also three different wheat futures markets, each trading a different type of the grain.  The three tradable varieties are:  hard red winter wheat (traded in Kansas City) which makes up about 40% of the U.S. crop, soft red winter wheat (traded in Chicago), and finally red spring wheat (traded in Minneapolis).  Winter wheat is seeded in autumn and winter, remains dormant while the weather is cold, and grows in the spring.  Spring wheat is planted, believe it or not, in the spring.  The main growing areas for hard red winter wheat are Oklahoma, Texas, and Kansas, for the soft red winter wheat, Illinois, and North Dakota is the biggest producer of spring wheat.

Two Different Extremes

The hard red winter wheat crop is under a lot of stress due to continued drought (see map).  Over the past 30 days, parts of Texas, Oklahoma, Kansas, and Colorado have received less than 25 percent of their normal rainfall.  Some areas in Texas have been experiencing temperatures in excess of 100 degrees Fahrenheit.  The USDA reported that 92% of Oklahoma is in drought, with the Southeast and South Central districts the driest since records began in 1921.  Weather reports show little chance of rain over the next week. 

In North Dakota, where the bulk of the spring wheat crop is grown, they are facing the opposite problem.  Melting snow coupled with ample rainfall may cause flooding in the northwest, and the Red River is expected to rise to major flooding levels this week for the third year in a row.  The spring wheat crop is seeded in April and May, so persistent flooding and high soil moisture can keep farmers out of the field and delay or prevent planting from taking place. 

None of this spells a shortage of wheat, at least not in the near term.  The USDA recently reported U.S. ending stocks that remain on the high end of historical norms (see chart).

U.S. Ending Stocks – Wheat
Courtesy of Bloomberg

Export Demand

Wheat is the most common internationally grown crop in the world.  It is grown virtually everywhere, however the U.S. is the largest exporter.  Due to crop problems in other parts of the world, it is likely that there will be strong demand for U.S. exports. 

Last year, the worst drought in 50 years wiped out 37 percent of Russia’s wheat crop.  In response, Russia enacted an export ban that was set to expire on July 1st of this year.  More recently the government decided to extend the ban until the size of the new crop is clear.  Russia is traditionally the world’s third largest exporter of the grain, and some analysts are speculating that it could actually become a net importer this summer, building inventories as a precaution in case they have a repeat of last season. 

Australia, the fourth-largest exporter, is also having problems with drought.  The Australian Bureau of Agricultural & Resource Economics (ABARE) said last month that this year’s crop will fall to 24.3 million tonnes, down from last year’s record crop of 26.3 million tonnes.  If there is continued dry weather in Western Australia, the largest wheat growing area, this could be reduced by as much as 4 million tonnes. 

As a result, demand for U.S. wheat was strong last year and could remain strong through the following season.

U.S. Export Demand – Wheat
Courtesy of Bloomberg

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