Wheat prices need differentiation from commodities

by Morton Sosland
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Now that wheat prices have been below a year earlier for a little more than four months and as 2008 nears its close, examining the forces that account for the remarkable price gyrations of the past year as well as what the future may hold seems appropriate. As a reminder, the peak for wheat futures prices on any exchange, at $24 per bushel, occurred in the March 2008 contract on the Minneapolis Grain Exchange in late February. The contract high at that time for the December contract, which expires this month, was $13, and the low for the latter, recently recorded, was under $6. Lesser, but nearly as astounding, swings occurred in both Chicago and Kansas City. To describe this volatility as historic or unprecedented understates the concerns these swings created in grain-based foods.

One of the central questions in addressing what happened in wheat is determining the degree to which this performance stemmed from the nearly parallel moves of commodity prices in general and how much may be attributed to fundamental supply-demand forces at work in wheat alone. At the peak of these prices, the blame "game" was highlighted by pointing to numerous villains, particularly trading by hedge and index funds created to allow financial investing in what could best be termed the total commodity market. Often heard were allegations that unchecked and nearly mindless buying of wheat and other commodities by these entities caused prices to soar to history-making levels. Proposals aimed at curbing this sort of investing usually assert that these actions undermine the utility of futures for commercial hedging.

Ascribing the climb in wheat to unrestrained investing in commodities as an undifferentiated sector, whether used as essential food or in industrial applications, gained broad acceptance. Much of this view’s authority stemmed from attention to soaring demand for commodities from China, where double-digit economic growth impacted many global commodity markets. It is amusing that these enthusiastic interpretations sometimes extended to wheat, even though China buys not a single bushel from external sources. While not wanting to refute the worry about commodity trading, it suddenly makes sense, in studying subsequent declines, to conclude that market fundamentals continue to have the major sway. Early fears about unlimited demand for all commodities, including wheat, have given way to realizing that the bread grain, like other agricultural commodities, would experience a crop increase in response to price strength.

This price-driven flexibility in production as well as the inflexibility of demand for such a basic foodstuff explain why wheat ought not be treated as just another commodity. Indeed, the weakness in commodity prices in the last half of this year underscores these differences. Oil and metal prices have fallen primarily because early sharp advances caused a sharp contraction in demand; the earlier upturns precipitated little in the way of added supply. In contrast, wheat and other agricultural commodities have fallen in the same period largely as a result of a marked expansion in supply, while demand, as measured by disappearance, is actually increasing.

Once that marked difference is understood, attention ought to turn to factors that will determine whether prices for wheat and the other grains will return to average levels of the past decade or so, or will remain at what is still relatively high levels. This is the issue that best fits in a broad survey of commodities, including the belief, expressed several weeks ago on this page, that prices for crude oil, as long as corn-based ethanol is the leading alternative to gasoline, will have much to do with both corn and wheat prices. This is the point where understanding the direction and dimension of energy supply and demand might be a more productive arena for focus by grain-based foods than movements of commodity prices. The latter are too often lumped into an index that has little to do with the costs of grain-based foods’ most important ingredient.

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