This Is What I Have Studied

• This is my personal study notes for agricultural commodities.
• Refence book: Dunsby, Adam, John Eckstein, Jess Gaspar, and Sarah Mulholland. Commodity investing: maximizing returns through fundamental analysis. John Wiley & Sons, 2008.

Overview

• Wheat is the staple food of mankind; it's a cereal grain and globally the most important grain for human consumption.
• Wheat is grouped into two categories based on its growing season
  • Winter wheat is planted in the fall and becomes established before a period of dormancy during the winter. When spring comes, the winter wheat resumes its growth until an early summertime harvest.
  • In areas where the winter is harsh, spring wheat is planted during the spring. It then is harvested in the late summer or early fall.

Production

• The majority of the world’s wheat production is grown as winter wheat in the Northern Hemisphere.
  • Large spring wheat crops do occur in Canada, Russia, and the United States.
  • In the Southern Hemisphere wheat producers plant after the spring wheat crop in the Northern Hemisphere.
    • This creates a smooth supply of wheat year round.
• Worldwide production of wheat has begun to take a back seat to production of corn and soybeans.
  • Wheat production has lost its luster as demand for corn and soybeans has increased at a faster pace than demand for wheat.
  • In addition, declining returns relative to other crops have helped entice farmers to switch away from planting wheat.
• The European Union (EU-25) leads the worldwide production of wheat with approximately 20 percent of the market during the 2005–2006 marketing year.
  • Other countries that produce a large quantity of wheat are China, the Former Soviet Union (FSU-12), India, the United States, and Russia.
    • Combined, they accounted for almost 80 percent of world wheat production in the 2005–2006 marketing year.
  • Other countries, such as Australia and Canada, are also important with regard to their levels of wheat production.
    • The two countries are large exporters of wheat
  • The production of wheat in the United States is extremely important to the worldwide market. This is because the United States is the largest exporter of wheat.
    • Approximately half of the country’s production is exported each year.
• As with other agricultural crops, the weather is an important factor in the final crop yield for wheat.
  • Some damage can occur during the pollination stage, when high temperatures and severe drought will reduce the number of grains set.
  • With regard to winter wheat, the market is primarily concerned about winter kill.
    • Winter kill results when there is no snow to cover the winter wheat and to allow it to lie dormant and protected during the winter season.
    • When there is no snow cover to provide moisture and protection, the cold can have an adverse affect on exposed wheat.
    • In addition, repeated freezes and thaws during the winter can cause the soil to heave and lift the wheat plants out of the ground.
  • Otherwise, of all the grains wheat is the best in making adjustments to adverse weather conditions.
    • It takes a lot to actually kill it.

Consumption

• Wheat consumption per capita has been in decline for almost 20 years. This is in comparison with corn, where per capita consumption has been rising during the same period of time.
  • Why is this? One of the reasons is that as diets become more diversified and disposable income rises, demand for more expensive foods such as meats, fruits, and vegetables replaces demand for wheat.
  • On the other hand, corn is used in a variety of applications outside of food such as industrial uses and ethanol. The lack of additional uses for wheat results in slower growth in demand over time.
• Wheat is primarily consumed in the form of flour used to bake breads, cakes, crackers, pasta, and other edibles.
  • The flour is made by putting wheat kernels through the milling process.
  • The wheat milling byproducts bran, germ, middling, and shorts are also produced.
    • These milling byproducts are used by feed manufacturers in the production of livestock feeds.
• Worldwide consumption of wheat is dominated by China.
  • Most of the wheat consumed in China is produced within the country.
  • China imports only a small amount of wheat.
  • Other large consumers of wheat include the EU-25, FSU-12, India, Russia, and the United States.
    • Together they constituted almost 70 percent of worldwide wheat consumption in the 2005–2006 marketing year
    • They are also some of the market’s largest exporters.
• Unlike the corn export market, which is dominated by one player—the United States—the wheat market has a number of exporters.
  • The United States happens to be the largest wheat exporter, but it faces competition from the FSU-12, Canada, Russia, Argentina, and Australia.
  • This diversity of exporting countries provides stability to wheat trade and prices.
    • The result is lower price volatility for wheat than in the corn market, because the corn market relies on one country’s production for the majority of the world export market.
• Since wheat is primarily consumed in the form of flour, other cereal grains and starchy food substances can be considered substitutes.
  • Besides wheat, flour can be made from many other crops such as corn, barley, rye, and rice.
  • Wheat flour is considered superior because of its gluten content.
    • Rice flour is very important in Southeast Asian cuisine. Corn flour is widely used in Mexico in tamales and tortillas.

Storage

• Countries have different marketing years depending on when they begin to harvest the new crop.

  • In the United States, the wheat marketing year runs from June through May.
    • In the United States, winter wheat is harvested starting in June.
      • Much of this harvest is put into storage to ensure supply throughout the marketing year.
  • In wheat, the international marketing year is from July through June.

• The normal market futures curve for wheat entices the farmer or storage operator to store grain for later by paying for some of the storage costs.

  • This normal futures curve for wheat is also called contango, when the near future month is cheaper than the further out future.

• If the price of the near future is higher than the further out future, the curve is inverted, or backwardated.

  • An inverted curve implies that the market wants the wheat now and is not willing to pay the cost to store it for later.

Futures

• The benchmark wheat future is the Chicago Board of Trade (CBOT) wheat future.
  • The CBOT wheat future has a contract size of 5,000 bushels and trades in cents per bushel.
  • It has a tick size of $0.25, which means its minimum fluctuation can be a quarter of a cent.
    • Each tick has a tick value of $12.50.
    • This means that if you were long one contract of wheat at 460.00 cts/bu and you sold it at 460.25 cts/bu your profit before commission would be $12.50.
  • The CBOT wheat contract trades future months July, September, December, March, and May of each marketing year.
• For smaller investors the CBOT has an E-mini wheat futures contract.
  • This contract is one-fifth of the size of the regular CBOT corn futures contract.
  • Each E-mini soybean future has a contract size of 1,000 bushel, a tick size of 0.125 cents/bushel, and a tick value of $1.25.\
  • The E-mini wheat future can be physically delivered.
    • The delivery specifications are the same as those of the full-size wheat future.
• The rules regarding delivery of wheat futures are outlined in depth in the CBOT Rules and Regulations Handbook.
• Worldwide there are additional wheat future contracts, but none are as liquid as the three in the United States.
  • The most liquid global wheat futures are listed on the Winnipeg Commodity Exchange in Canada, The Australian Stock Exchange, and the LIFFE exchange in Europe. Information regarding these future contracts can be found through the exchanges.

Price History

• As with corn, the price history for the CBOT wheat future is remarkably range bound.
  • The wheat price in a range of 200–400 cents per bushel most of the time since 1975.
  • Events
    • In 1980, unfavourable weather conditions resulted in low wheat crop yields.
    • In 1996, a combination of strong export demand during the 1995–1996 marketing year and concern over the winter wheat production resulted in low stocks for wheat.
      • Stocks usage is the expected ending stocks for a given marketing year divided by the total demand for the same marketing year.
    • Not long after the low stocks usage situation in 1996 there occurred a long period of low prices and high stocks usage beginning with the 1997–1998 marketing year.
      • This occurred because farmers reacted to the high prices in 1996 and planted extra wheat accordingly as their profit margins increased.
• The future outlook for wheat prices is mixed.
  • Demand should remain steady, yet the supply side could have many changes.
    • The most likely change comes from increasing competition for acreage from other crops such as corn and soybeans.
      • Farmers that have the ability to plant multiple crops on their land will choose the crop with the highest profit margin.
      • This battle for acreage will result in more competition between products for land and the potential for higher price correlation among crops.
      • Overall wheat prices should lag gains in other crops as demand growth will be slower.
    • As with other crops, the weather will play an important part in determining yields and thus production for each year’s harvest.
      • Poor weather will lead to price spikes similar to those seen in the past.

Market Reports

• The monthly World Agricultural Supply and Demand Estimates (WASDE) published by the USDA is a great source of fundamental information on the wheat market.
  • In this report, the USDA publishes production, demand, and stock estimates for wheat as a whole and separated by classes.
  • In addition, supply and demand estimates for the world wheat market are made.
• Others
  • The Economic Research Service (ERS) section of the USDA has a variety of research reports along with a wheat briefing room on its website (www.ers.usda.gov).
    • This briefing room will give you an overview of the United States and world wheat markets in terms of supply and demand, trade, and policy.
  • The National Agricultural Statistics Service (NASS) section of the USDA provides useful statistics with regard to both supply and demand.