I just survived my 19th wheat harvest, and I didn’t even get a t-shirt. This year was relatively uneventful compared to some years, outside of basis collapsing at the start and never really recovering after. Quality was decent for the most part across the heart of my trade territory, outside of some regional issues reported due to too much rain.
I would venture to say wheat is the most complex market out there, so complex many seasoned traders say to avoid it, calling it a variety of names, none of which are very nice.
What makes wheat so complex is the different classes, or varieties of wheat that are grown. Each of these classes have their own unique supply and demand set ups, varying throughout each wheat producing region. Commodity tourists can bet on wheat and win, as we saw after the Ukrainian invasion last year, or previously in late 2020 when Russia began adding export taxes and the inflation trade began. But many times, as we have seen so often over the last year now, it chews up and spits out anyone just passing by thinking it looks like an easy trade.
As mentioned, the complexity of wheat comes from the different classes produced and how their individual market structures influence one another. Here in my home state of Michigan, we grow soft winter wheats, both red and white. Soft winter wheats are planted in the fall the year prior to their summer harvest and are used primarily for the fun stuff, cakes, cookies and crackers. Soft winter wheats are grown throughout the Eastern Corn Belt, with soft red the primary type, while white wheat is also heavily grown in the Pacific Northwest.
Hard Red Winter Wheat is grown in the Southern Plains, and like soft winter wheat, is planted in the fall prior to its summer harvest. Hard red wheat is used for hearth breads, rolls, and flatbreads.
Bread products are where Hard Red Spring Wheat shines as well. Different from its winter wheat cousins, spring wheat is planted in the spring and harvested later in the summer or early fall. Spring wheat is the hardest of wheats, with protein an important grade factor. Durum wheat is also grown in the Northern Plains and Canadian Prairies where spring wheats are traditionally grown. Durum wheat is primarily used to make pasta.
Climate and soil types influence where certain varieties of wheat are grown, with wheat being planted or harvested somewhere in the world nearly every day.
With the different varieties being so regionally influenced and traded in their own markets, someone who has been successful in wheat for any amount of time will tell you the physical market influences futures direction in a way not seen in corn and soybeans.
So having said all that, let’s take a look at what is happening big picture-wise when it comes to wheat around the world.
From a supply standpoint, not much is different from last year, with global production outside of China relatively steady. Production in Russia was slightly below last year’s levels according to the USDA, though official USDA numbers never reconciled with private estimates for the 2022 crop.
Ukrainian production came in close to last year’s levels thanks to good weather, while European production as a whole looks like it will come in steady versus last year as well. Drought in the Canadian Prairies has cut their production outlook in a big way from a year ago, something the USDA will have to recognize in their September update. Production in the US was a mixed bag, with increased acres offsetting some yield loss in the Southern Plains, a big increase in Soft Red Wheat production, with a slightly smaller spring wheat crop, and lower durum production expected.
While harvest is wrapping up across the Northern Hemisphere, the crop is entering its important production period in the South. After three record crops in a row, Australian production is likely to be much lower this year, with the transition to El Nino typically resulting in drier than normal conditions. Production in Argentina is likely to be reduced by drought again as well, while in Brazil another large crop is expected.
Quality issues seem to be more prevalent this year than in any in recent memory, with damage to the Chinese crop keeping the possibility of major imports there on the table. Elsewhere protein issues and falling number worries could create some interesting local market dynamics, with this needing to be kept in mind as some of the reasoning behind the interesting trades we could see as a result. Many times, quality issues in wheat are worked out via basis, or through premiums or discounts, making for interesting arbitrage opportunities at times, as well as possible spikes in values paid if certain quality specifications are required.
On the demand side of the ledger, as mentioned, China remains a major wildcard, with upwards of 30 million metric tons of wheat (1.1 billion bushels) possibly damaged by heavy rain at harvest. The damage to the crop has pushed basis levels higher for quality wheat and pushed off spec wheat into the feed market.
India is another major wildcard. Like China, India is one of the world’s largest wheat producers, using most of their production domestically as well. Below normal monsoonal moisture and above normal heat has reduced India’s crop two years in a row, causing domestic wheat prices to spike. Traders in the country believe the government needs to import around 9 million metric tons (331 million bushels) to stabilize supplies and calm prices. This would be non-traditional demand, and not in the current supply and demand outlook projections published by the USDA.
Demand elsewhere remains concerning though, with cash strapped governments around the world finding their budgets depleted as the cost of just financing their debt soars. Even if we manage to avoid a global recession, many of the countries traditionally reliant upon wheat imports are managing much tighter budgets in the face of a market that requires a lot more capital to buy and hold supplies.
Tepid demand is evident in tender results, with Egypt’s government buying arm purchasing just a small percentage of the supplies bought a year ago, even with prices down significantly.
What it all means, is wheat is the market with both the brake and the gas pedal smashed to the floorboard. There are production issues abound that have likely been hidden by the more than adequate supplies currently available—this not even mentioning the fact the world’s largest wheat exporter is one misplaced missile or unmanned drone away from disrupted shipments.
However, with the current high interest environment we find ourselves in and the geopolitical dynamics making it necessary for Russia to keep supplies flowing while EU and US exporters do their best to compete, we find prices over $2.00 cheaper on the Chicago board than a year ago.
Dynamics this fall for next year could be explosive, with heat and dryness expected to continue into the fall planting season in the Southern Plains, possibly reducing production there yet again. Here in my backyard, low prices and big acres last fall are likely to reduce this fall’s plantings significantly, something that is expected to be seen throughout the Eastern Corn Belt.
However, with VSR triggered in Chicago wheat—TLDR on VSR: a tool created by the CME to add increased carry to the market in times of burdensome supplies to encourage wheat be stored, designed to help firm nearby basis—the market structure screams far more supply is currently available than demand.
The increased carry structure in the market makes for a dangerous environment for spec longs as well, as they find themselves stuck choosing between rolling their length forward at a loss or just liquidating the position.
Overall, wheat has the potential for big runs when we least expect it, driven by headline risk or big demand from China or India. However, the overall market structure will likely cap gains, making open orders key when it comes to capturing rallies.
Other things I am watching this week:
--Logistics. Levels on the Mississippi River continue to drop, limiting grain flow out of the Gulf for the second year in a row. This combined with issues at the Panama Canal could cause problems with our competitiveness out of the Gulf but could help demand out of the PNW in a big way.
--Turkey’s President Erdogan and Russian President Putin are scheduled to meet tomorrow. Ukraine has sent two more ships out of closed ports through their humanitarian corridor, while Russia needs to ship about 1 mmt of wheat a week to meet expectations. Could we see Putin try to make the Black Sea Grain Initiative a factor again as he sees his power in the region slipping?
--Weather and harvest results. Weather is expected to remain less than ideal for grain finish, but likely to push up harvest progress. True yields will have my attention for the next several weeks.
There are plenty of other moving parts to monitor, but those are the big ones for now.
As always, don’t hesitate to reach out with any questions. Have a great week!
On the date of publication, Angie Setzer did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
