A falling dollar, food inflation and biofuel production have pushed corn and soybean prices higher and are expected to continue through the growing season. While the supply/demand balance may continue to favor bulls in those markets, wheat is a different story as supplies are more ample in 2011 than those of corn or soybeans.
Unlike corn and soybeans, whose exportable supplies are grown primarily in North and South America, wheat is a global commodity grown throughout the world. While weather issues in some of the larger producers spiked wheat prices last year, production is getting back on track in 2011.
In addition to supply, wheat is not fully sharing in the demand boom experienced by corn and soybeans. BRIC nations (Brazil, Russia, India and China) are experiencing explosive growth of a new middle class that rapidly is adding meat to its diet. Corn and soybean meal are a main component of many animal feeds. In addition, corn also now feeds a demand sector from the ethanol industry. The USDA estimates that more than 40% of the 2010/11 U.S. corn harvest will be turned into ethanol.
Wheat is not used for biofuel production. And it comes in a distant third as an animal feed. While wheat prices still benefit from growing populations and potential inflation it has not matched corn and soybeans in adding new avenues of demand.
In grains, there is no greater fundamental than the stocks-to-usage ratio — a figure that measures the amount of stocks available at the end of the crop year vs. the projected demand for the upcoming year. While the 2010/11 U.S. stocks-to-usage ratio for corn approaches the second lowest on record at 5% for 2011 and soybeans stocks-to-usage tumble to a paltry 4.2%, wheat stocks-to-usage remain at a hefty 34.2% for the year (see "Well stocked"). This is a primary reason why wheat has not tracked corn and soybeans. And, despite production setbacks in Canada, Russia and Australia last year, projected global ending stocks-to-usage in wheat is a healthy 27.6% in 2011.
These supply figures indicate that the wheat market will enjoy a more stable supply cushion to begin the 2011/12 harvest season than will corn or soybeans. But those supplies are, as they say, "in the barn." The market will now turn its focus to growing season 2011.
While weather concerns can pop up anywhere, the severity of 2010’s problems is rare. More "normal" weather patterns are expected for much of the major wheat producing regions. Countries such as Russia are expected to lift export bans imposed last year as a result of domestic production shortfalls. India will begin exporting wheat for the first time in four years, and is expected to harvest a record 84.3 million tons this year. Most importantly, however, is that wheat enjoys a much larger margin for error than does corn or soybeans due to its healthy ending stocks. This should make its price less susceptible to sudden surges than that of corn or soybeans. True, wheat probably will lose the acreage battle to corn and soybeans in the United States this year, and most likely will perform as a weak sister in the grain and oilseed complex in 2011. This means it will lag corn and beans in a bull market and lead the way in a bearish reversal.
For these reasons, we see wheat as an excellent hedge for traders already short corn and soybean puts. Option writers look to sell deep out-of-the money puts in bull markets and deep out-of-the money calls in bear markets. However, bull players who sell puts often will sell calls as well to take advantage of overpriced strikes far above the market even if they think prices will continue higher. This is especially true this time of year when grain prices often correct once planting is complete. Instead of selling bean or corn calls, stay short the puts in these markets and sell your calls in wheat.
If bull market conditions continue, wheat calls likely will appreciate more slowly than those of corn or soybeans. In a corrective environment, their profit likely will offset any temporary pressure on soybean or corn puts. The object, of course, is to have all of them eventually expire worthless.
James Cordier is the founder of investment firm Liberty Trading Group/OptionSellers.com. Michael Gross is an analyst with Liberty Trading Group. They wrote "The Complete Guide to Option Selling," 2nd Edition (McGraw-Hill 2009). Visit them at www.OptionSellers.com