Newsom on the Market

By Darin Newsom
DTN Senior Analyst

It's early Friday morning, well before dawn here in Omaha, and I'm still thinking about this column I turned in Thursday afternoon. It was hard to write, so much so that not even the comfort of my wheat-made Kentucky friend in the hours between then and now made me feel better about the fact I'd written it. But what's done is done. Nothing to do now but move forward. Today is another day.

Cliches. Nothing but cliches.

Like "separating the wheat from the chaff." If one of the market's unwritten jobs is to separate the profitable from the unprofitable, the good from the bad, where does wheat fall?

In early July I wrote a column titled "The Last Wheat Harvest." There I sowed the seeds of an idea that the U.S. no longer needed to grow the greatest crop on earth. And, as expected, I received a number of responses ranging from agreement to pointing out the major flaw in the plan: What else should U.S. farmers plant? That's a great question with no easy answer.

Now, let me spread a little fertilizer on those seeds I sowed. Over the last couple of weeks I asked for some feedback on the numbers involved with growing wheat. I heard from a grower of a variety of wheat classes in Idaho (grows what will pay the most and fit rotation) and a number of Southern Plains farmers.

Here's what I found out, in a nutshell: The average cost of growing wheat, per bushel, runs from roughly $5.50 to $5.80. This Thursday evening saw DTN National Indexes (national average cash prices) calculated at approximately $3.68 (SRW), $3.15 (HRW), and $4.51 (HRS). I update my national average basis (DTN National Indexes minus the close of nearby futures) tables every Friday evening, with last week's "goes-in-ta's" (thank you Gomer Pyle) resulting in average basis so far this marketing year at 36 cents under (SRW), 42 cents under (HRS), and a disheartening 88 cents under for HRW. I then compared these averages to the five-year averages of 33 cents under (SRW), 20 cents under (HRS), and 44 cents under (HRW), easily arriving at the conclusion that basis is much weaker than normal, despite futures prices moving to new multi-year lows (I'll touch on that more later). Suffice it to say this type of market relationship (weak basis, weak futures) doesn't normally happen.

Visiting with wheat growers, particularly those in the Southern Plains, the cash story is actually worse than it seems. Both old-crop (2016) and new-crop (2017) basis has recently dropped to more than $1.00 under the respective nearby and new-crop July (winter wheat) futures contracts. Thursday afternoon saw Kansas City July close at $4.68 1/4 -- mere pennies off its contract low of $4.61 3/4 set back on July 5.

Here's what we have then: A breakeven cash price for HRW (the largest wheat crop grown in the U.S.) of roughly $5.65, and a forward contract price (new-crop basis minus new-crop futures) of approximately $3.65. A $2.00 loss, per bushel. If the crop averages 35 bushels per acre, that's $70 in the hole for each acre of wheat harvested.

So what if instead of actually, physically planting wheat we raised our crop on paper?

World fundamentals are bearish, regardless of what we hear about crop problems in Europe. Using Chicago (the most heavily traded wheat futures market) as a proxy for the world wheat complex in general, therefore reflecting global supply and demand, its forward curve (series of futures spreads) shows an old-crop carry of 59 1/2 cents from the September futures contract to next May's. The new-crop futures spread (July 2017 through May 2018) has a 56 1/4 cent carry. What do all these numbers mean? The stronger the carry, the more bearish the market's view of supply and demand. And Chicago wheat's forward curve is about as bearish as one can imagine.

Therefore if we buy the 2017 crop on paper, we'd almost have to go out to the May 2018 futures contract priced at approximately $5.26, or $1.25 over the close of September 2016 contract. That simply doesn't work.

But what if we could hold our existing physical cash supplies for the next year rather than growing a new crop? Depending on variable storage rates that could amount to almost $1 in fees off the top, and it's hard to imagine cash prices moving far enough to offset the cost. That doesn't work either.

If DTN Cash Index futures (listed on the Minneapolis Grain Exchange) had any trade at all, they'd be a viable option to replace physical cash with paper cash bushels. Then storage costs would be avoided and the index futures wouldn't have to rally as far to start to be profitable. As for risk, recall that actually growing a crop could cost $2.00 per bushel, so one would own wheat on paper and set the same $2.00 loss limit for futures. That means the DTN National HRW Wheat Index would have to drop to $1.15. My long-term charts don't go back far enough to find the last time cash HRW was that low.

The bottom line is, and the thing that's hardest to accept because this isn't the conclusion I thought this piece would come to: There are no good answers for wheat growers. The question of what else can you grow persists at a time when there is also too much of the alternatives -- namely milo, corn and soybeans. You lose if you grow wheat. You lose if you try to own wheat on paper. Damned if you do. Damned if you don't.

Cliches. Nothing but cliches.

Darin Newsom can be reached at darin.newsom@dtn.com

Follow him on Twitter @DarinNewsom

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