World stocks of wheat are at an all-time low. Many hoped that other starch grains like rice, barley, corn or sorghum would make up for the shortage and prices would remain in check. But “Got any bread?” (below) depicts the stocks of all starched grains per person. Left over inventories are down to a mere 100 pounds. That’s it — one bag, about 52 day’s supply for the next year. That is all each person in the world would have for every loaf of bread, noodle, cake, bagel, cereal, gluten product, corn starch product (like soft drinks and plastic garbage bags), soup, gum, beer, alcohol, glue, batteries, paper products, drugs, soaps, and, yes, even ethanol for fuel, just to mention a few things. There is no more until the next crop is harvested.
This is the tightest situation the world has ever seen. If there is an acreage reduction or adverse weather that effects any production of starched grains, then the world would need to start buying the remaining stocks, the 100 pounds of grain that is left. That threat, heightened by a drought in Australia, sent governments and corporations around the world chasing the market to get supplies secured for the upcoming year. Accentuating this price move were trading funds that saw this shortage and invested billions into wheat futures in hopes that the bet would pay off and prices would move to historical new highs.
The bullish market in wheat (see “How high can wheat go?” above) has made a radical impact on different sectors of the market place, opened the door for some massive profit potentials and is creating some new trading opportunities for the investor to consider. Prices of wheat have rallied from a relatively normal price of $3.40 per bushel to a current high of $9.61 — nearly triple the normal price and $2 above the previous all-time high, an historic move by any measure. Demand has been split into those countries and corporations that no matter what the price, will provide an adequate and safe supply of food and product to their people/customers. This is inelastic demand, and if there are further supply disruptions, they will continue to chase prices higher. The other sector of demand are those who are willing to sell their inventory at three-fold the normal price for a huge profit, and force their population/clients to simply cut consumption. This is called elastic demand. This might be an ethanol plant that takes profit by selling their inventory at current prices and shuts down the plant for four months until new supplies are available at a lower price; or a manufacturing company cutting the starch out of their paper or polymer products. That is price discovery, where greed and fear become opportunity. That is economic equilibrium, where profit opportunity outweighs the benefit of the product. This is a historic event and the demand curve will remain in place for a long time.
But the high price is not only having an effect on demand. Farmers around the world are looking at the price of wheat relative to other crops they grow and are planning on taking advantage of a rare opportunity. The dashed line in “Growing money,” (below) depicts how wheat prices relative to corn are at an all-time high. The solid line depicts the strong correlation to acreage shifts. Projected revenue on an acre of corn for 2008 is $544 less the $512 cost for a profit of $32 per acre. At today’s price, wheat can generate $560 less $305 cost for a profit of $255 per acre. Farmers in Southerland, Neb. are planting 1500 acres of wheat this year compared to the normal 220 acres they plant. Villages in South Africa like Strydkraal (Irrigation - Northern Province) and Qwa-Qwa, Thaba Nchu, Hennenman (Dryland-Free State Province) are not only increasing the acres they plant, but because prices are high, can afford to use new varieties and technology that will fight plant diseases and result in better yields.
The historic rally in wheat prices not only offers opportunity for the processor to reduce his starch mix in polymers or the farmer to increase his profits by switching his crop production mix to wheat, but it creates several new trading opportunities for the trader. The obvious one is to short the wheat market. Selling one futures contract will require that $2,025 be maintained at all times. If prices fall to “normal levels” ($3.40/bu.), profits would equate to $31,000. Not a bad return. But remember that if there is any perception that crops around the world are threatened, the demand would be chasing that 100 pounds of starch grain left over from last year, which is not much to go around. Using options like a covered call position or a spread against other starch grains like corn would be advised to help manage risk in a market that is extremely volatile.
Another not so obvious opportunity is to buy corn, beans, rice, or barley futures when the charts suggest a fall low is in place. If a farmer who normally farms 2,000 acres of corn, 2,000 beans, and 200 acres of wheat is now planting 2,000 acres of wheat, then what crop will not get planted? Looking at “Plant rotation,” (below), if acres of corn decline enough to allow increases in wheat and beans, there will not be corn produced to meet demand. So unless the reduced set-aside programs in Europe result in large offsetting supplies, the market will have to get prices to levels that either encourage larger U.S. production by balancing the U.S acreage numbers or discourage demand for U.S. grains. There is another way, however. There could be a change in U.S. government policy that currently restricts planting through Conservation Reserve Programs (CRP). This, however, is not likely as recent comments by the secretary of Agriculture suggested despite his counterpart’s decision in Europe to eliminate set-aside, he favors the market determining what the mix of acres will be given the current acres in production.
No matter what the marketplace decides for acres, one lesson the world has learned is that 100 pounds of starch stocks per person is dangerously low. Food security is too important and the risk and implications of running short on food are too great to allow the current trend to continue. It will be the markets job to cause behavioral change on the demand side as well as the supply side. Elastic demand will eventually sell to take advantage of high priced inventory and farmers from the U.S. to Africa will respond as well via increased production. These price benchmarks will provide plenty of trading opportunities in the grain and oilseed futures and options as this historical dilemma is resolved.
Bill Biedermann is senior vice president of Allendale Inc., a futures research and commodity brokerage firm (www.allendale-inc.com). Biedermann can be reached at bbiedermann@allendale-inc.com. Allendale agricultural market analysis can also be found on www.futuresmag.com.
