Wheat outlook keeps slowly improving

Summary:

• Wheat has been the least affected by global trade wars

• There is space for US wheat exports to bounce back

• Frothy stocks in China along with high domestic prices

• Some export restrictions possible in some countries

• Wheat looks strongly overbought in the short-term

Grains prices have been in a downtrend since 2012 but now we could say that this trend has been terminated - this is the case at least for wheat. The price has been rising since the start of the year breaking its long-term bearish trend line (price action differs in case of corn and soybean).

The latest price rally was halted slightly below the 38.2% retracement of the entire decline since 2012. Note that this time was different compared to the rise taking place in mid-2017 as the price was able to gain much more. Bulls ought to eye 520c per bushel as their first defense line. Source: xStation5

The wheat market has evolved over the recent years. Investors used to a global supply surplus which led to the price collapse to below 400c per bushel in 2016. However, on the back of the lowest profitability compared to corn or soybean (at least in the US) we have seen substantial changes in production. Global harvested acreage of wheat has been falling for several years which in conjunction with adverse weather conditions has led to a decrease in supply.

Global harvested acreage of wheat. Source: USDA

This year’s season for winter wheat in the US was remarkably weak unlike spring wheat which turned out to be pretty well but only in the US and Argentina. Elsewhere in the world a wheat crop has been definitely lower due to unfavourable weather conditions. As a result, we have been offered the largest production deficit since 2012 - basically it is the first deficit over the recent 6 years.

A tremendous wheat production deficit in the world. Source: Bloomberg, USDA, XTB

On the flip side, the record level of stocks is expected this season in the world, and despite quite high demand for grain the stocks-to-use indicator keeps climbing (the inverted axis at the chart below). Note that the neighbourhood of sub-0,4 level led to a reversal in the past.

Global wheat stocks are the highest on record which has brought the stocks-to-use ratio to the extremely high levels. Source: Bloomberg, USDA, XTB

In spite of the fact that market participants expect a production deficit the overall outlook for wheat does not look well which could be tied to China. The world’s second largest economy has seen the gargantuan increase of inventories over the recent years which account for 46% of total wheat stocks in the world. Why are these stocks unlikely to fall? Firstly, these are strategic reserves. Secondly, the constantly rising demand in China along with frothy prices should keep the country’s stocks in check.

The white line represents the wheat price in terms of US dollars in China. Even as we have seen heavy falls of late the price remains still around 100$ above the US export price which in turn is lower compared to European grain. Source: Bloomberg

How does the outlook look when we take China out of our analysis? It turns out that we are experiencing a huge shrinkage of stocks around the world. This along with poor production in the world could be a threat to low prices. Note that the stocks-to-use ratio is currently the highest since the 2008/2009 season.

Excluding China the global stocks-to-use ratio looks encouragingly. Source: USDA, XTB

As depicted above the overall outlook for wheat keeps improving. Weak output globally, potential voluntary export restraints from Russia and Ukraine - these factors could lift prices. Note that such export limitations occurred during the GFC in 2008/2009, and then in 2010-2012 which led to a massive decrease of Russian exports in order to keep up with domestic consumption. There is guesswork that both countries could decide to introduce such limitations over the next weeks or months. It is worth noticing that when wheat exports from Russia and Ukraine tumbled the US exports jumped. The chart below illustrates the exports-to-production ratio for major wheat exporters. Possible falls in the two post-soviet countries would benefit the US, and this is especially true as prices remain relatively low.

A decrease of Russian and Ukrainian wheat exports could be a chance for the US. Source: Bloomberg, XTB

However, short-term factors need to be taken into consideration as well. Wheat is remarkably overbought in the short-term as evidenced by the weekly CFTC data as well as the seasonal pattern. The current level of net long position is the highest on record increasing the likelihood to see a larger pullback.

Speculative positioning on wheat in the highest on record - a possible contrarian signal. Source: Bloomberg

Seasonal patterns suggest that wheat prices should lose momentum in the nearest term. Source: Bloomberg, XTB

In the near-term we think that wheat looks overvalued being shored up by revelations regarding low production in Europe or Australia. Having said that, we do not see too much odds for a bearish trend comeback, but a corrective pullback may occur which could be in line with seasonal patterns. Looking beyond the near-term wheat prices seem to be in a good position to bounce. Note that larger rises could occur when either Russia or Ukraine implements some export restrictions.