Kub's Den

When coal miners sent caged songbirds down mineshafts to indicate the presence of deadly carbon monoxide if their chirping stopped, the little birds' deaths occurred somewhere dark, cold and drippingly damp. In contrast, if a wheat plant dies, its death probably occurs somewhere sunny, dry and dusty -- maybe too cold, maybe too hot (temperatures could reach 80 degrees in Amarillo this Thursday). Yet both of these little organisms may serve a similar purpose in their sacrifice: Warning of threats to a broader population, if conditions don't change.

Wheat futures have rallied lately, ostensibly driven by drought conditions in the Southern Plains of the United States. Sure enough, it's the KC wheat contracts representing hard red winter wheat (the variety most commonly grown in the Southern Plains), which have led the rally, gaining 22% since January. Chicago wheat and European milling wheat have also moved higher (with 18% and 7% gains, respectively), and Australian and Black Wheat prices have also been rising, but Minneapolis spring wheat futures have so far barely shifted, with gains of only 4% since January's low.

I find the rally interesting for two reasons.

1) With as much excess wheat inventory as there is in the world today, why should any blip in supply anywhere really bother end users enough to start bidding into a rally?

2) Looking at the seriousness of the current drought, and acknowledging that it's more than a blip, I wonder if it foreshadows similar droughty problems for the rest of the wheat market, and for corn and other row crops too.

The answer to the first question lies in the scope and scale of the drought. The U.S. Drought Monitor shows 20% of the High Plains region in "severe" or worse drought, up from only 3% three months ago. The center of that red blob on the drought map looms right over the panhandles of Texas and Oklahoma, oozing up into Kansas. In other words -- wheat country. And, although most of Nebraska looks okay at the moment, fully 67% of the region is experiencing some kind of abnormally dry conditions, and it doesn't end at the region's borders, or even the nation's border.

The most recent Canadian Drought Monitor shows a massive dollop of "severe" and "extreme" short- and long-term drought conditions right around Regina, with moderate drought stretching all across the Prairies of Manitoba, Saskatchewan, and Alberta. Again -- wheat country. Basically, all of North America's main milling-wheat producing regions have drought concerns right now.

This may not be the appropriate time to hit the panic button for spring wheat, yet, when the Canadian Prairies and the U.S. Northern Plains are still covered in snow. But by the second week of April, South Dakota farmers tend to have 25% of their spring wheat seeded, so the appropriate time for panic is drawing nearer.

It's absolutely the appropriate time for panic in the Hard Red Winter wheat market, represented by KC futures. The National Agricultural Statistics Service, in statewide reports this week, showed that a majority -- 53% -- of Kansas and Texas wheat fields are already rated either very poor or poor.

These wheat fields will either be abandoned, grazed or harvested well before any corn or soybeans get harvested in this country, so it makes sense that the wheat market will reflect a drought's weather risk premium earlier than the row-crop markets do. History bears this out. In 2012, the KC wheat contract's rally was sparked in mid-May, followed by the corn rally beginning in mid-June. The same pattern was shown in 1988 -- KC wheat futures started rising in mid-May and then corn futures started rising in June.

Looking at this now in the middle of March, I still believe Corn Belt farmers should stay disciplined about marketing their grain ahead of harvest at profitable prices, still assuming normal production levels and not getting too bulled up about a potential drought in 2018.

And yet...

"It's not out of the question for the Southern Plains drought to edge into the western and northwestern Midwest this summer," DTN's Ag Meteorologist Bryce Anderson told me. "It does look like Pacific Ocean temperatures will warm to Neutral ENSO values by early to mid-April, but that doesn't mean that La Nina effects will suddenly go away. Southern Plains dryness likely stays on through summer and affects the central Plains as well. Couple that with a temperature trend that looks to be near to above normal, and there could be some heat and dryness issues outside of the already dry Southern Plains this season."

One final warning for bullish grain traders who have stopped hearing the canary's sweet whistles down in the coal mine: There truly is still a lot of wheat, and a lot of feed grain, in the world. Even in the U.S. some classes of wheat will be more sensitive to supply shocks than others. Hard red spring wheat has a 36% stocks-to-use ratio, according to the latest WASDE report, but soft red winter wheat will retain in inventory 76% as much wheat as the market uses. In addition, even if the millers in North America do someday struggle to source certain classes of wheat domestically, there is a whole world willing to ship in what they need. European milling wheat at 170 Euros per metric ton FOB Rouen this September could get to our East Coast at $6.70 per bushel, assuming very generous shipping costs. So there is some limit to how far this rally could go.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

(CZ/BE)

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