Wheat futures could be shaping up to be one of the more interesting commodities futures markets over the winter months. There is already evidence that the market might be getting its maths wrong on the global wheat reserves picture. Part of this scenario is based on the fact that global grain stocks are assessed on the assumption that the beneficial free trade environment the world has enjoyed over the last 20 years is going to persist. We would argue that may be naive.
Wheat futures to be boosted by falling production
World wheat production is falling, which could potentially boost demand for soybean and corn futures, but many commodities analysts are including Chinese stocks in their calculations. China may not be prepared to dump its wheat stocks on the global market. If that is the case, expect wheat futures to trend much higher in the next six months.
There is also the weather to take into consideration. According to Fitch, crop damage from a La Nina weather cycle could really push agricultural commodities like wheat considerably higher. Analysts are focused in particular on the US harvest this year, but hot summer weather in Europe is also likely to have had an impact. Keep one eye on the Ukrainian harvest. Ukrainian and Russian farms provide much of the wheat to the Middle East and last time bread prices were high in the Arab world, governments started to topple.
“World production is falling below demand this year,” says Bryce Knorr, a senior grain market analyst at Farm Futures. “And with El Nino in play it looks like wheat production will be reduced sharply in Australia. Overall world wheat ending stocks – without China – could be the lowest in a decade.”
So let’s talk about China, shall we? The wheat stocks to use ratio of the major net exporters of wheat like the USA, Europe, former Soviet countries and Canada are as low as they have been since 1960. The global population was a lot smaller then too.
Lack of clarity on China commodities market
Ratings agency Fitch worries that there is currently a “lack of clarity” about the Chinese government’s position on agricultural commodities and that this will mean more volatility in wheat futures in the coming months. More light will be shed on this at the 19th National Congress of the Communist Party, which takes place in October. China is currently implementing a five year plan, which started in 2016. Part of that plan is to further liberalise commodity production markets, including some farming. Analysts think this could have a negative impact on China’s ability to produce wheat. Farmers will chase prices, rather than planting what they are told to plant.
“We are forecasting for global grain surpluses to evaporate and for markets to trend closer to deficit in 2018/19, which informs our view that prices will rise from spot levels and average higher year-on-year,” said Fitch in its latest grain futures forecast.”
Fitch agrees that wheat futures will see enhanced volatility over the coming months. Implied volatility for grain options – using corn as an example – is running at multi-year lows if you use the front month contracts in CBOT as examples.