Market Strategy: Will Wheat Come to Life?

December 1, 2010 03:52 AM

The time may be right for wheat to come to life. For many months, wheat stocks have been viewed as excessive. When any commodity with negative fundamentals can post and hold a near 50% rally, it gets my attention, as it should yours.

I have long viewed U.S. soft red winter wheat futures as a precursor to what could be in store for other commodities, especially corn. This year, wheat made its big move from early July to early August, well ahead of corn and soybeans, and carved out a trading wedge or pennant as if it were buying time and waiting for corn and soybeans to catch up. Subsequently, soybean and corn prices exploded higher and weather got drier, reducing the incentive to plant wheat.

With the U.S. crop off to a shaky beginning and the first survey-based estimate of planted acres not available until Jan. 12, uncertainty will continue.

A breakout phase to the upside for wheat will be the first indication that the large stocks of wheat might be needed to help fill the void in exportable feedgrain stocks. This could be the catalyst needed for wheat to seek higher levels.

MarketStrat Dec10 ChicagoWheat

Attack Plan. Knowing that a poor crop of wheat in a major exporting country could cause a rally, patience is needed as the final act plays out. A breakout to the upside means a $1 to $2 potential move higher. Purchases of wheat for feed by Russia or even China could do the trick. Absent a surprise demand scenario, a sideways range continues with $6.50 lead-month futures providing support.

I will watch weekly and daily indicators for signals going into the Jan. 12 Acreage report from which to make long-term decisions, while eyeing the benefits of storage gains on 2010 inventory.

Under the Chicago wheat cash convergence scheme, the market carry to July is nearly 70¢ for six months of storage or a 20% per annum rate of return. It is also a place to protect the 2011 crop via July futures and put options. Any demand shock will likely narrow the market carry, thus making March call options a viable strategy to re-own old crop for a possible gain, as well as protect cash or hedges against a possible production shock into February, when we can reassess price projections.

My crop insurance price is set at $7.19, meaning I have price risk above that level on 100% of my crop. Given big U.S. stocks against a backdrop of world needs, locking in downside protection while leaving the upside open seems reasonable. Figuring 85% revenue coverage, I hedge 15% of my actual production history at $7.70 and buy a $7.70/$7.20 July put spread for a cost of 28¢ on 85%. If prices drop below $7.19, my selling price on that 85% will be $7.41. If prices rally, my risk-management cost is limited to 28¢ and I have another decision to make at even higher prices and will have to adjust my strategy.

I will have covered my downside risk until insurance kicks in on the 85% and will have sold the 15% of noninsured wheat at $7.70 (minus basis). Should prices explode, 85% of my production will benefit, minus the 28¢ risk-management cost.

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Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact him at or (312) 896-2090.

Top Producer, December 2010

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