Todd's Take

HRW Wheat's Unexpected Rally

Todd Hultman
By  Todd Hultman , DTN Grains Analyst
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The accompanying chart shows spot Kansas City wheat prices off to a bullish start in 2018, fueled by concerns of drought in the southwestern U.S. Plains. Unsuspecting noncommercial traders have been under pressure to buy back their short commitments and still have more to cover (Source: DTN ProphetX).

In the world of grain markets, nothing moves prices like talk of drought and, in early 2018, we already have two significant regions at risk -- Argentina and the southwestern U.S. Plains. Here in the U.S., July Kansas City wheat is up more than a dollar a bushel in 2018 -- a substantial move that was unimaginable back in December when traders were focused on 2017's record global wheat harvest.

Few are thinking of last year's crops now as the southwestern Plains have turned dangerously dry. Just a week ago on Feb. 26, the state NASS office said 49% of winter wheat in Kansas was rated either poor or very poor. More recently, wildfires became a growing concern as the weekend turned windy, and late Monday, KWCH Eyewitness News in Wichita, Kansas, reported a large grass fire in Clark County, Kansas. On the same day, the National Weather Service in Hastings, Nebraska, reported fires in Furnas and Smith counties in south- central Nebraska, and the Texas A&M Forest Service reported a 100-acre fire in Motley County in northern Texas.

From a larger perspective, having prominent drought conditions threaten a U.S. winter wheat crop that represented less than 5% of last year's global wheat production does not, by itself, make a strong case for a bull market in wheat. However, there are a couple factors that have given Kansas City wheat an added boost in early March.

First, while the U.S. drought may not have a big impact on world wheat supplies, it can bring about a noticeable reduction in U.S. wheat supplies as winter wheat represented 73% of all U.S. wheat production in 2017. The possibility of say, 700 million bushels of U.S. ending wheat stocks in 2018-19, instead of a billion bushels in 2017-18, eases some of the bearish pressure on wheat and corn prices, even while the world may remain well-supplied.

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Second, and more important for short-term purposes, it is the surprise of this winter's drought that best explains the strength of the recent rally. In December, when the mood was overwhelmingly bearish, noncommercial traders held a record high 122,683 short commitments in Kansas City wheat. Not only were traders bearish, they were confidently bearish.

Week after week of no rain increased the area of extreme drought conditions around the Texas Panhandle, which eventually scared potential sellers away and made it increasingly difficult for all those bearish shorts to buy back their contracts. Subsequent rallies in late January and again in late February added to the financial pain.

In the world of futures markets, the weakest position on the board is a noncommercial trader who goes heavily short and then runs into an unexpected bullish situation. Within the group, it's not uncommon to find some who made promises they weren't prepared to keep, and that adds to the anxiety level to get out. This winter's drought served as the perfect catalyst for a classic bear trap and noncommercials are still caught against the trend.

Friday's CFTC data showed noncommercials short 62,441 contracts, down roughly half from their December peak, but still showing plenty of fuel for more rally if the weather continues to stay dry. Yes, forecasts can change and that is why they need to be monitored, but as we look out from Monday, the forecast remains mostly dry for the southwestern Plains, from three days to the next three months.

Weather markets are notoriously volatile and, because we are dealing with traders under emotional and financial duress, trying to predict a top is futile. The best approach I know in situations like this is to pay attention to the short-term trend, and so far, that trend clearly remains up in July Kansas City wheat.

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Todd Hultman