Wheat - Is history going to repeat itself?

Summary:

• Wheat’s fundamentals are mixed

• Trade Wars as one of the major risk factors

• CFTC data suggests continuation of decline

• Wheat price has been trading within consolidation range for the past couple of years

• We expect wheat prices to decline further

Despite improved fundamentals commodity price has been under pressure in the previous weeks. In general the production is falling, especially in the US, what improves the outlook for commodities. Nevertheless, when it comes to wheat (unlike soybean or corn) it is also important to pay attention to the global production figures. In this analysis we highlight some factors that may justify the continuation of the current downtrend. We will take a look at fundamentals, technical analysis, seasonality, speculative positioning and geopolitical factors that may influence wheat prices.

Falling production does not translate into lower inventories

United States are one of the major wheat producers and exporters. Apart from the US among notable producers and exporters one can name EU, Ukraine or Russia. Nevertheless, despite deteriorating production outlook in the US (lowest since 2003) inventories keep rising pointing at lower prices.

Wheat inventories rise putting downward pressure on prices. Source: xStation5

Given the 1-year forecast one may notice that wheat stocks remain at their highest level on history, the 1-month forecast has been slightly lowered though. Having said that, stocks in general have yet to fall in the pace implied by a difference between output and consumption. Basically, one may argue that this difference is negligible, which together with a dormant demand is not a clear signal of the long-term trend change.

Seasonality is a key to price outlook

Wheat is the best performing grain among major three. Nevertheless its price is falling along with the whole grain market. However, it is worth to note that in general wheat tends to behave less effectively than corn or soybean therefore there is a risk of wheat price adjusting to the price of other grains. Of course one needs to take into account geopolitical factors. Still, when we take a look at the seasonality we can see that the grain market tends to decline in the first half of the year to rebound at the end of third quarter.

Wheat has been outperforming other grains so far this year. Source: Bloomberg, XTB Research

When we take a look at the last 5 years we can see that prices of grains tend to decline in the second half of the year. Source: Bloomberg, XTB Research

It is worth to note that the wheat price (green line) has outperformed both agricultural index (white line) and grain index (yellow line) lately. In the previous years after such outperformance the wheat price usually retreated back to the level of agricultural index what would suggest a decline towards 400 cents per bushel.  Source: Bloomberg, XTB Research

Speculative positioning suggests reversal

Often when analyzing commodity or FX market investors take into account net speculative positioning. At the moment we can see a textbook example of what reversal signal according to CFTC could be. Long positions are declining from extreme highs while short positions are building up from the extreme lows. Given the divergence between net position and price we get a clear sell signal.

CFTC positioning data suggests that reversal may be looming. Source: Bloomberg, XTB Research

Geopolitics

One of the major factors that has been influencing wheat prices lately was geopolitics. Tariffs imposed by the US result in other countries taking retaliatory steps. Out of all tariffs imposed the Chinese ones impacted wheat market the most (despite soybean being the main target). In case the US decide to impose tariffs on cars imported from i.e. Japan, Mexico or South Korea those countries may retaliate targeting US wheat. This is the scenario US wheat producers fear the most.

Out of all countries that may be target by the US tariffs South Korea is the only one to increase wheat imports from the US. Source: USDA, FarmCentric

US Wheat Associates (USW) was the only organization to warn that imposing tariffs on steel and aluminium may result in retaliatory steps. The organization has already signalled that tariffs take their toll on the wheat exports. Nevertheless, USW warns that imposing tariffs on car may have even greater consequences as car imports are far bigger than imports of metals and therefore potential retaliation may be bigger too.

In the past years we have seen price reacting adequately to the bearish engulfing patterns. Moreover, volume is declining after the latest surge. A buy signal could be generated by a major contraction of trading volume, just as it was in December 2016 and 2017. Taking into consideration all of the factors mentioned above expect wheat prices to decline towards the 452 cents per bushel (61.8% retracement level of the last upward impulse) and later on toward 435 cents per bushel (78.6% retracement level and upper limit of the demand zone). A stop loss order of such transaction could be placed above the closure of the last monthly candlestick (around 530 cents per bushel). Source: xStation5