Attempt to explain $1.50 wheat price mystery

by Morton Sosland
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Anyone looking for a wheat market mystery that merits pondering ought to think hard about how to explain why current wheat prices appear to be $1.50 per bushel higher than what would be expected in relation to earlier years. That substantial difference, equal to more than $3 per hundredweight of flour, represents the national average farm price for wheat in the 2009-10 season as well as the latest forecast for 2010-11, compared with prices prevailing in the three crop years ended in 2005-06. Supply-demand calculations for those three years might be regarded as considerably more bullish than was the case in the year just ended and is in the outlook for the season that began in June. Yet, farm prices for wheat in 2009-10 averaged $4.90 per bushel, with the projection for the new year very similar, in contrast to the $3.40 and $3.42 national averages ruling in those three earlier years.

This premium of an additional 44 per cent collides with supply-demand figures that accentuate the mystery. When it comes to the ending stock-to-use ratios, the lower the ratio is, the more bullish the connotation. The current ratio for 2009-10, at 46.8 per cent, is nearly double the ratios computed at the close of the three seasons beginning with 2003-04. In size, the actual ending carryover in 2010 was two-thirds greater than the largest carryover in those three years. As if the weight of these numbers was not sufficient to press down on prices, the 2009-10 wheat supply was about 200 million bushels larger than in any of the earlier seasons.

From a demand point of view, the data are also relatively bearish. Total annual disappearance will lag the pace of the earlier period by as much as 300 million bushels. Export surprises, which in the past have often provided enough fireworks to set off a price explosion, seem totally unlikely. Shipments in 2009-10 were the smallest in several decades and lagged the outgo of those three earlier years by nearly 200 million bushels. Competitors for export markets, notably the states of the Former Soviet Union with easy access to the Black Sea, face no worrying setbacks in their efforts to build upon their newfound role as major wheat exporters.

Government programs, another past source of substantial support for prices through a variety of channels, are largely absent. The direct payment rate, based on normal yields, has been at 52 cents per bushel for the entire period under review. While most studies indicate that wheat farmers will be more inclined than other crop producers to choose the ACRE program (Average Crop Revenue Election) in sign-ups this year, as compared to staying with the program of direct payments, marketing loans and counter-cyclical payments, the impact here is most likely in firm prices for wheat real estate. But the likely effect of all of this on market prices in the near term is minimal, especially when direct payments are made without regard for prices received.

It has become customary in seeking to understand the rationale for current wheat prices to cite two influences beyond supply-demand — the role played by commodity index funds as a strengthening force and the prospect for currency value fluctuations that would move demand in a price-affecting way. Without dismissing the net bullish effect of index funds that count ownership of cash wheat as holding a basic commodity position, buying of index funds by investors has been more restrained of late than it was during 2007-08 to the point that doubts are cast upon its impact. Absent fundamental explanations as well as economic factors to account for the current level of wheat prices leaves standing the most central of all assessments — that the market itself is never wrong. As a result, speculative fervor joined by a willingness to respect the strength of wheat foods in the global diet may be sufficient to explain this mystery.

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