Todd's Take

The Wild, Wild West of Wheat

Todd Hultman
By  Todd Hultman , DTN Lead Analyst
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USDA is estimating U.S. ending SRW wheat stocks at 39% of use in 2019-20, but does it matter? (DTN ProphetX chart).

If there was ever a grain that could be described as an overachiever, it has to be soft red winter (SRW) wheat. Only accounting for one-seventh of U.S. wheat production, SRW wheat is known in the futures market as Chicago wheat, and consistently attracts more trading volume than any other U.S. wheat contract.

As a common example, Thursday's daily volume in December Chicago wheat reached 43,705 contracts while December Kansas City wheat could only manage 32,520 contracts and December Minneapolis wheat recorded 6,626 contracts traded. Both KC's hard red winter wheat and Minneapolis' hard red spring wheat represent U.S. crops over twice the size of the SRW crop, but they never seem to garner the fame that Chicago wheat has held over the years, tracing back to the glory days of pit trading in the Windy City.

One thing you may not know about SRW wheat is that it is the dumbest of the three wheats. Ask any economist how prices are determined, and you will hear an explanation of the interaction of supply and demand. The lower the surplus at the end of the season, the higher the price and the higher the surplus, the lower the price.

The funny thing is, I plotted 19 years of DTN's National SRW Wheat Index prices, from 2000 to 2018, arranged in order of where USDA estimated ending SRW wheat stocks each month. I have done this for all the major U.S. grains and typically found R-squared values of somewhere between 54% for corn to 32% for HRW wheat.

The R-squared value is a statistical measure, which represents how much of the change in a commodity's price is explained by changes in the underlying ending stocks-to-use ratios. Fifty-four percent to 32% are not what you would call high correlations, but at least they acknowledge some significant relationship between the two variables.

In the case of SRW wheat prices, there is zero statistical correlation to its U.S. ending stocks-to-use ratio. None. Nada. Historic prices are scattered randomly, no matter what USDA says about ending supplies.

Before we completely give up on logic, here's a possible explanation. Perhaps SRW wheat is just too small of a fish in a big lake of wheat production. Maybe its own specific fundamentals give way to U.S. wheat fundamentals, in general.

Plotting the same 19 years of SRW wheat prices, according to the ending stocks-to-use ratios for U.S. wheat production in general, did offer some improvement. The R-squared value increased to a measly 12%, but at least the regression line sloped down and to the right, as it should.

Once again, however, we are confronted with the realization that despite as much work that goes into estimating and measuring all the factors of supply and demand, much of that effort goes unappreciated by the market's actual prices.

Okay, so SRW wheat prices don't show much response to their own fundamental measures. How are we supposed to think about wheat prices? What do SRW wheat prices correlate to? For the most part, they correlate to other commodity prices, especially corn and soybeans.

A couple years back, I did a study of correlation coefficients among different commodities over a 20-year period and found high correlations among various commodity prices, even those you would not normally suspect.

With possible answers ranging from no correlation of zero percent to perfect correlation of 100%, Chicago wheat futures had 89% correlations with corn and soybean prices, 84% correlations with copper and gold, and a 77% correlation with crude oil.

Among the three U.S. wheat contracts in 2019-20, SRW wheat has the lowest ending stocks-to-use ratio of the group, but I don't expect that to be a significant factor in the months ahead.

To really see significant improvement in wheat prices, a change in the mood of the entire commodity sector would be a big help. With this year's headlines of slower world growth related to rising tariffs, I have to say a bull market in commodities doesn't seem likely... at least anytime soon.

Todd Hultman can be reached at Todd.Hultman@dtn.com

Follow him on Twitter @ToddHultman

(BAS/CZ)

Todd Hultman