Chip Flory: Be Ready to Hedge Wheat

March 8, 2018 01:38 PM
 
Chip Flory

It can be frustrating to be a wheat producer. Traders generally don’t believe yields can be hurt by drought, frigid temperatures or being flattened by a heavy snow in May. You’ve heard comments such as “wheat’s a weed” and “wheat has nine lives” so many times they barely faze you or the market.

This past year was an exception, though. Drought in the northern Plains sent spring wheat futures higher than $8, but hard red and soft red winter wheat futures couldn’t even top $6. In the winter wheat contracts, the 2017 crop scare was just another failed upside breakout attempt in the longer-term downtrend from the 2012 high. The long-term downtrend in spring wheat futures was broken, but futures are back to bouncing off support at $6.

Drought from the Dakotas south into the southern Plains and in Australia this winter has the wheat market in a state of confusion. U.S. winter wheat crop conditions in January were some of the lowest on record, as were top- and subsoil moisture levels. All things considered, it’s natural to anticipate crop concerns this spring resulting in higher prices. If that does happen, be ready to sell a crop-scare rally. That’s true for corn and soybeans, as well, but it’s definitely true for wheat.

Sure, a significant crop issue can be “generally bullish.” But for wheat, grading differences, protein levels and all other quality issues make price discovery too complicated for futures. The cash market is much better suited to account for quality and grading difference than the futures, which is why wheat futures are willing to quickly abandon price support from a short crop.

That’s not to say wheat futures won’t offer pricing opportunities. They normally do—it’s just that weather rallies in wheat tend to be compressed, straight-shot rallies that accelerate when the market “runs out of sellers.” That creates a vacuum and prices are sucked higher until willing sellers step forward. And then wheat futures fall as quickly as they rallied.

Producers are typically the first to step in as sellers in a weather rally. Not necessarily U.S. producers, but wheat crops around the globe are hedged in the U.S. market—and because wheat is harvested 12 months a year, the market is never lacking for willing hedgers. While a U.S. crop scare supports prices, growers in the Ukraine might be harvesting a bumper crop and selling aggressively.

This spring, the wheat market is about being prepared for opportunities. One strategy is price targets to make cash sales at profitable levels. Another is price targets to establish downside price protection with hedges. Being willing to hedge is different than being ready to hedge. Prep work to hedge a potential wheat rally this spring (when you lack confidence in production) should include margin planning with lenders now to maintain profitable hedges later.

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