Few financial assets have gotten off to as good of a start this year as Chicago wheat has, adding over 5.0% in 2020 to pair with its 11.0% gain in 2019. While the performance itself has been impressive, it is also worth noting Chicago wheat is now challenging the highest levels since 2015 after scraping decade lows just a couple years prior. So, it begs the question of where the strength is coming from, and with wheat, the answer is always more nuanced than it appears on the surface.
When discussing wheat, it is always best to start with a look at the by-class balance sheet. The soft red winter (SRW) wheat balance sheet saw planted acres in 2019-20 fall to the lowest since 2010-11, while harvested acres fell to 3.733 million, which were the lowest on record going back to 1986-87. Total supplies for the 2019-20 marketing year fell to 402 million bushels (mb) from 495 mb the year before, and were also the lowest since 1986-87. The low wheat prices from 2015 to 2019 have slowly been doing their job as carryout dropped from a seven-year high in 2016-17 of 215 mb to a projected 106 mb in 2019-20. Winter wheat acres planted in the fall of 2019 totaled 5.64 million acres versus 5.201 million the year before, according to USDA, so there is a possibility we've seen the low-water mark for SRW acreage
While supplies on the balance sheet are important, supplies held in CME Group deliverable warehouses are even more important. The wheat held in these warehouses is known as "the supply of last resort" as CBOT futures are backed by physical product as opposed to cash-settled indices on other exchanges. As of Jan. 17, there were 22.845 mb of soft red wheat in deliverable warehouses. This was down 1.887 mb on the week, and down a little over 30 mb from the year before to the lowest deliverable stocks since 2007-08. The 30 mb drop is down 56% from the previous year, which is drastically more than the 18.7% decline the USDA sees in total wheat stocks. If an end user cannot buy wheat in the cash market, they should always be able to stand in for delivery by being long Chicago wheat futures. If the supply of deliverable stocks and the amount of wheat registered for delivery declines to levels like we are seeing now, it is a good indicator the holder of that wheat and those delivery receipts is not going to part ways with them easily. The struggle between end users wanting to own wheat and commercials not wanting to part with their stocks helps us think about how futures can rise and calendar spreads can tighten.
Supply has been the largest driver of the price rally, but demand has also played a crucial role. The wheat behind the Chicago contract is SRW wheat, which is ideal for low-protein products like crackers and pastries. While no commodity demand is completely inelastic, there are times when a certain class of wheat can bring a value much higher than what one would perceive. Cash basis along the Ohio and Mississippi river systems is trading at 40 to 50 cents above gross delivery equivalence, meaning end users are having a very difficult time sourcing the bushels and the quality they need. Bids at the Gulf of Mexico for No. 2 SRW wheat are currently around 120 to 130 cents above the March futures board. These values would be 30 to 40 cents above a year ago and 60 to 70 cents above the three-year average. Countries like Egypt wouldn't take a second look at U.S. SRW wheat at these prices, but places like Mexico, Columbia and Nigeria remain consistent buyers because of the end use qualities they need.
One cannot talk about wheat and basis without discussing calendar spreads. The March/May calendar spread is trading a 1.25-cent inverse at the time of this writing. This compares with a 5.75-cent carry a year ago, a 12.75-cent carry two years ago and a 13.75-cent carry in 2017. For many years, Chicago wheat was the darling of managed funds because of the huge carries offered from the Variable Storage Rate (VSR) program. The hefty supplies of SRW wheat and the relatively tepid demand created great incentive for commercials to store wheat and funds to remain short futures. When funds are long and roll in a carry market, their "purchase price" is increased by the amount of carry. When funds are short in a carry market, however, their "sale price" is improved by the amount of carry. If futures volatility stayed low, as it did in wheat from 2015-19, funds could simply collect the positive roll yield from being short and deploy risk capital in other markets. As supply dynamics began to change in 2019, so too did calendar spreads.
Funds losing their carry market can be illustrated rather clearly when examining their positions from the CFTC. Funds ballooned their net-short position in Chicago wheat to 117,833 contracts on April 30, which was the largest net short since January 2018. Funds began to cover that position into summer, hitting a net short of 13,693 contracts on July 2 after harvest. They built the position back to a net short of 56,685 contracts on Sept. 3 before covering and going net long 6,424 contracts as of last week's data. To give a sense of just how rare it is that funds are net long in Chicago wheat, the average fund position for all weeks going back to Jan. 1, 2007, is a net short of 53,778 contracts. The amount of carry or inverse in Chicago wheat is likely to be a large indicator of fund positioning in 2020.
Chicago wheat has enjoyed an impressive run to finish 2019 and begin 2020. Much of the rally has been driven by the drop in SRW wheat production inside the United States due to weather and years of low prices. Producers responded to the oversupply situation by cutting planted acres to decade lows while Mother Nature cut harvested acres to record lows. Because of the unique characteristics of SRW wheat, the highest prices in nearly five years have not completely shut off demand. Finally, the structural changes to the Chicago wheat market removed the comfortable carries so many have been accustomed to, including managed funds. The speculative community responded in kind by moving to a very rare net-long position. The question now becomes whether they will be comfortable in extending that long position throughout 2020.
Tregg Cronin can be reached at email@example.com
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