Barclays: Future of wheat price is tightly coupled with corn

Wheat market fundamentals are less compelling than Corn or even soybeans, but substitution in demand and supply will mean the trajectory of corn prices will have a decisive effect on how Wheat trades, says Barclays

Poor weather in key producers has not affected production, while a return of Black Sea exporters and a record Indian crop will likely have a direct effect on increasing global export availability. However supplies for high protein wheat grades will remain tight.

Global wheat consumption, especially for feed, is likely to receive a boost from the tight level of corn supplies. In addition to a tighter corn balance sheet, the price differential between wheat and corn has seen a swift reversal of the historical relationship, with corn trading at a prolonged premium to wheat since June this year.

CBOT wheat prices have trended lower in 2011 so far. Front-month prices have traded in a fairly wide range, from a low of $5.65/bushel to a high of $8.93/bushel, which is the strongest level since August 2008. Barclays view wheat prices as having modest upside over coming months, although price gains are likely to be tied to the fortunes of corn prices.

Across different grades of wheat as well, supply of feed wheat and lower grade wheat remains more comfortable, while supply of higher protein grades wheat is tight, also reflected in the relative under-performance of CBOT wheat vis-à-vis KBT and MGE wheat prices.

Speculative sentiment towards the CBOT wheat market has been weak over recent months. Non-commercial net fund length rose to the year’s high of 42.6K lots in February, after which fund positions started declining and falling into net short territory in mid-May for a week. Since mid-June, however, net fund positions have stayed in net short territory with early Augusts’ level of 41.4K lots the highest short position since June 2010.

Global wheat production is estimated by the USDA to be 672.1mn tons – the third highest level on record, with the latest USDA August WASDE report revising production up 9.7mn tons. Sources for the upward revision stemmed from countries where weather-related supply concerns have materialized in lowering supply, such as China and the EU, as well as the Black Sea region and India, where higher production is likely to have a direct effect on increasing global exports.

European production was plagued by concerns about the effect of continued dry weather in the spring planting season, especially in higher protein grade wheat producers such as Germany and France. However, early harvest results reflect higher yields than expected following rains in June. Similar supply concerns were rife early on in the year regarding drought and water shortages in China’s northern wheat-producing areas.

However, for 2011-12, China’s production is expected by the USDA to be 117mn tons –second only to 1997-98’s all-time high. However, the spectre of increased supplies has really come in the form of an increase in the return of an increased exportable surplus to the global market from the Black Sea producers and India.

A drought last year led to Black Sea production being slashed by a third, leading Russia to a ban on Wheat exports and Ukraine imposing a grain export quota. A rebound in Black Sea production and the return of Russia in particular to the global wheat export market in July after an 11-month hiatus have been the key supply side factors weighing on prices. The price competitiveness of this region means price-sensitive consumers have shunned more expensive EU and US wheat in favor of Black Sea exports.

The USDA’s August WASDE report upwardly revised both Russian and Ukrainian production in 2011-12 by 3mn tons and Kazakh output by 1mn tons. This has led to Russian exports estimated at 16mn tons, compared with 4mn tons in the previous year, and while traditional export destinations so far have been Middle Eastern countries such as Jordan, Egypt and Tunisia and potentially Barclays may see Asian importers sourcing Black Sea wheat as well on attractive prices.

The other area in which production has continued to surprise to the upside and there exists an exportable surplus exists is India, the world’s second-largest producer where the USDA estimates wheat production at a record 85.9mn tons. India banned wheat exports in 2007 following a poor harvest when it had to turn to imports to meet demand, and that ban remains in place despite domestic production having grown in leaps and bounds since.

India is still contemplating wheat exports after the four-year ban, although the price competitiveness of Black Sea exports will likely keep import demand for Indian wheat exports weak. Meanwhile, wheat stocks at Indian government warehouses are bulging, currently more than double the target of 17.1mn tons, with further pressure from a record crop in the offing.

Global wheat consumption, especially for feed, is likely to receive a boost from the tight level of Cornsupplies and Barclays expect an upward revision to the USDA’s estimate of wheat demand. In addition to a tighter corn balance sheet, the price differential between wheat and corn has seen a swift reversal of the historical relationship, with corn trading at a prolonged premium to wheat since June this year.

Meanwhile wheat imports into China YTD are below y/y levels, but the latest June data showed a surge in imports at 279.8Kt and imply increased wheat demand substituting for tight domestic corn supplies and high prices. Global inventories, although lower y/y, remain fairly comfortable in 2011-12. With supply growth looking healthy, a return of Black Sea exporters to the global market and the expectation of exports from India, Barclays believe wheat prices have modest upside over coming months.

Price direction in good measure will be driven by corn, although Barclays expect wheat prices to underperform compared to corn and soybeans. Across different grades of wheat as well, supply of feed and lower grade wheat remains more comfortable, while supply of higher protein grades is tight.

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