Bryan Doherty: Wheat overvalued?
New crop wheat prices have been in a steady uptrend since the end of June, when July 2011 futures bottomed at 5.43-1/2. As of Tuesday of this week, the market reached a high of 9.09, or a rally of just under 4.00. So what's driving prices?
From a supply standpoint, the world had plenty of excess inventory moving into 2010. However, fundamental factors such as dry weather in Europe followed by a severe drought in Russia, and then massive flooding late this fall into early winter in Australia all helped reduce world carryout figures. Projected world carryout in 2009 was near 200 million metric tonnes and has since dropped to just above 170 million. While that drop in world projected carryout should relate to an increase in value, the market still, from a historical perspective, has an adequate carryout. In 2007, world projected carryout was under 130 million metric tonnes. Unlike corn and soybeans, which are experiencing projected world carryout and world stocks-to-usage figures very close to where they were in 2006, the wheat supply is nowhere near as tight. Therefore, a sustained price rally is questionable.
So what does it mean? Wheat prices are in an uptrend for six months now, and show no sign of topping. There are three fundamental factors that usually lead to a rally in wheat prices. One is declining world carryout year to year. That has occurred. Two, the perception that carryout may continue to get smaller due to disruptions in world supply. That has occurred with draught in Russia and a shortfall in Australia. Third, there is spillover support from higher prices of competing commodities.
It is likely that, currently, the wheat market has priced in most of the bullish news. There is, however, potential for higher prices if world supplies shrink. Dry weather in the western Plains and the southern U.S. could be the catalyst toward the next leg higher. High-priced call options may be an indicator that the market believes prices will move upward as well. From a producer standpoint, recognize that the market is substantially higher priced than where it was just a matter of months ago. This provides an opportunity. Be prepared to forward contract or aggressively buy puts or both. Fence strategies, in which you buy a put and sell a call, also appear to be attractive. However, make sure that you understand the margin ramifications of this position, should prices continue to rally. Whatever tools you use, know how big price movement can affect your bottom line. It is likely wheat is overvalued from a long-term perspective. Don't miss opportunity. Maintain a health balance of downward price protection and upside price appreciation potential.