December 9, 2011

Wheat wheat everywhere...but not a grain to eat
There's a lot of wheat around but most of it is not fit for human consumption. We examine the short and medium implications of this situation for feed grain prices.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS
Caught between macroeconomic uncertainty and anticipation, CBOT corn has stayed flat just under $6/bushel; with no scope for further movement before next week's USDA report. While the undercutting of US corn by Black Sea and Argentine sales to Asia played a role in the current market stagnation, another culprit has become obvious: wheat.
The disastrous Russian drought of 2010 initially jump-started corn's rally. This harvest, a surfeit of bountiful bumper crops is undercutting wheat prices and putting a cap on the prices of other feed grains. Canada, Australia, Russia, Argentina, Germany and Kazakhstan are just some of the countries that enjoyed a bumper harvest this year. The net result being that wheat inventories, which were plunging a year ago, will rise to 194.9 million tonnes, a shade below their all-time high of 204 million tonnes in early 2009.
Along with a bountiful supply of Australian wheat downgraded to feed grade earlier in the year, much more of it has been substituted in place of corn than could ever have been anticipated. Especially now, with CBOT corn and wheat roughly at price parity at just under US$6/bushel.

According to the UN FAO's latest report, "An important emerging feature is a sharp 8% increase in the use of wheat for animal feed, reflecting [wheat's] competitive pricing compared to coarse grains, maize in particular," Earlier, the FAO only expected feed wheat use to rise by 5.5%.

Similarly, US-based Steiner Consulting reported in its investor briefing that, "feed wheat from a number of key areas, such as the Black Sea region and Australia, is now competitively priced versus US corn." Along with Black Sea and Argentine exporters undercutting US corn by up to US$0.50/bushel in November, feed wheat is now keeping corn prices well below their 2011 highs. Along with the financial crisis, this is keeping corn approximately 25% below its earlier record highs, even there has been no rebuilding whatsoever of historically low world corn stocks.

Feed wheat's heavy impact on feed crop prices is compounded by a new round of harvest size upgrades.  Most recently, Canada upped its expected harvest by 4.6% or 1.1m tonnes to 25.3m tonnes, while Australia bumped up its wheat crop forecast a large 7.6% or 2 million tonnes, to 28.3m tonnes. Similarly, Argentina upped its own harvest estimate to by 12.5%, from 12 million to 13 million tonnes.

Benson Quinn Commodities noted that recent North American and Australian bumper harvests have added more deflationary pressure. Coming on the back of large Russian, Argentine and Kazakh harvests, it stated, "Expect exporters in both [countries] to become much more aggressive as both Canada and Australia have the potential to move forward with burdensome carry out levels." It concluded that, "The most likely scenario will be Canada, Australia and South American [wheat] origination points offering wheat more aggressively to traditional and non-traditional locations."

As is usually the case, there are several inflationary and deflationary factors in this whole scenario. First, on the deflationary side, due to the historically high prices for both grains the most number of acres planted with corn and wheat is forecast for next year's US crop. Although implicitly deflationary, such early forecasts should be heavily discounted: Please remember that high corn acreage was forecast for the current US corn harvest. Indeed, much corn was planted -and abandoned -when early floods and unusual mid-season heat took their toll.

Second, Kazakhstan's misfortune is proving to be a blessing for bullish investors: Part of the Black Sea region where much of the world's future feed grain will supposedly come from, millions of tonnes of the bountiful Kazakh crop is shut in by insufficient rail transport. All this is compounded by inadequate storage facilities. This alone will hardly dissipate this year's huge world inventories but it does keep a few key million tonnes of wheat off the world export market.

Third and most important, the current wheat bounty is about quantity, not quality: The reason wheat is pressing so hard on corn prices is because rainy weather in Australia, Canada, Germany and Ukraine degraded much of it to feed status. According to Standard Chartered Bank analyst Abah Ofon, any further downgrades to feed status, "could threaten food-grade stocks and will eventually send the market higher, particularly once vulnerable importers start to book deliveries."

Ofon concluded that while the downgrading of such a large proportion of world wheat supplies is deflationary over the short-term, the implied deficit of flour milling wheat will pull up prices over the longer term. Of course, if that happens, it becomes less economical to substitute it in place of corn, pushing up the latter's price too.

The time bomb of wheat quality versus quality can already be seen on the Minneapolis wheat market, where higher quality spring red wheat futures are traded. There, the spread between lower and higher quality wheat has been wide for some time. A similar trend is underway in the Paris wheat market, which trades European flour-mill grade wheat. In addition, both Minneapolis and Paris are seeing near-term contracts selling at a premium to longer-term contracts. Long term futures contracts are usually more expensive and the reversal of this price spread implies that despite the global wheat, quality stocks remain in paradoxically short supply.

On the macroeconomic front, there are also signs that the current grain price downturn might be ready to bottom out. French bank Société Générale noted that institutional funds have been exiting agricultural commodities since March but that this outflow is now slowing down. In November, investors removed a mere US$209 million from agricultural commodities, the slowest amount since July's profit taking on the back of high corn and wheat prices. It noted that during this time, among commodities, only gold enjoyed an inflow of investment -and this was due to the same financial crisis which is depressing grains to below their fundamental values.

At this point, much depends on next week's USDA report. Perhaps even more depends on whether financial markets will right themselves or suffer yet another seizure.

But this much is clear: While there is plenty of feed wheat to be substituted in place of other coarse feed grains, this is at most a short-term consideration. Over a longer term, the supply of flour milling wheat, not feed wheat, will determine the cost of wheat futures. Should demand for human grade wheat pull up its cost, even the fact it is in plentiful supply will not make it economical to substitute in place of corn. At that point, barring any financial upsets, both the cost of wheat and corn may begin to rise again.

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