Wheat Crisis: The Next Black Swan?

Although it's doubtful that anyone keeps track of such things, I'd venture to guess that 'crisis' has become one of the most popular words in the American lexicon over the last two years. The prevalence of the word in newspaper headlines and everyday conversation is an indication of just how bad the past few years have been. We've seen a real estate crisis morph into a global financial crisis, a swine flu crisis, too many industry-specific crises to count, and even a crisis on the high seas. Surely now the worst is behind us, right? Many prominent scientists throughout the U.S. and Europe are afraid not, fearing that the next market-crippling development could come from a most unlikely source: wheat.

Although most outside of Africa are unfamiliar with it, Ug99, a type of fungus commonly called 'stem rust' due to its production of reddish-brown flakes on wheat plant stalks, is a serious threat to eliminate 80% of the world's most widely grown crop. The fungus, which was first discovered in eastern Africa, has now jumped to Iran, with many crop scientists predicting that it is only a matter of time before winds carry the disease to Russia, China, and the U.S. (see this chart from the LA Times depicting the spread of the fungus).

Familiar Foe

Stem rust has hit the U.S. before, destroying 20% of the country's crop several times in the early 1900s. The last major outbreak was in 1962, when the fungus destroyed 5.2% of the U.S. wheat crop. After farmers successfully introduced stem rust-resistant genes to their crops, the fungus virtually disappeared for several decades, until a new strain was identified in 1999 in Uganda. Ug99 (named for the country and year of its discovery) has since spread to Kenya, Ethiopia, Sudan, and Yemen, becoming increasingly virulent along the way. New variants of the fungus have been discovered that can overcome many of the genes that previously protected the crop. Scientists are now working furiously to develop new strains of wheat that are resistant to the latest incarnation of stem rust, but such innovation is complex, expensive, and time-consuming.

Catastrophic Damage

Although difficult to predict with any degree of certainty, the damage from the spread of Ug99 could be staggering. The International Maize and Wheat Improvement Center estimates that 19% of the world's wheat, which provides food for 1 billion people in Africa and Asia, is in imminent danger. If the strain spread to the U.S., a significant portion of the crop, including more than 90% of wheat in ten states, could be vulnerable to devastation. By some estimates, up to $10 billion of wheat could be destroyed. If such a scenario played out, the impact of the virus could extend to markets across the globe, pushing up food prices and devastating those regions dependent on wheat for sustenance.

The Next Black Swan?

The Black Swan theory, popularized by Nassim Taleb's book, refers to events that were beyond the realm of normal expectations that had a major impact on the global environment. In his 2007 book, Taleb postulates that nearly all major scientific discoveries and major historical events were Black Swan events, including the invention of the computer, the rise of the Internet, and the 9/11 terrorist attacks. The term comes from the 18th century discovery of black swans, which disproved the previously accepted assumption that all swans were white. As such, it refers to a perceived impossibility that becomes a reality. According to Taleb, Black Swan events must (1) be a surprise, (2) have a major impact, and (3) be rationalized by hindsight after the fact.

The investment community was introduced to the Black Swan concept in 2008 when the Black Swan Fund, an investment vehicle run by 36 South Investment Managers, posted an annual return of more than 230% as equity markets around the world crumbled. By betting on events that were perceived as impossibilities, such as interest rate cuts in New Zealand and Australia and economic collapses in BRIC countries (the Black Swan Fund purchased put options), the fund capitalized on the crises that devastated most portfolios. 36 South recently launched a similar fund that seeks to capitalize if inflation rates in developed nations jump above 5%.

A devastating wheat fungus outbreak would certainly be a surprise. Even as scientists warn of imminent threats, few Americans have ever heard of Ug99. And it is only beginning to catch the attention of the investment community, as fears of a worst case scenario have begun to affect market prices of various assets. A few ETFs to keep an eye on as the Ug99 saga unfolds:

• PowerShares DB Agriculture Fund (DBA): This ETF holds a variety of agricultural commodities, including corn, wheat, soy beans and sugar. Despite pulling back from recent highs, DBA has risen in recent weeks on fears that a wheat shortage could drive global food prices higher.

• Van Eck Market Vectors Africa Index ETF (AFK): Although African markets have surged so far in 2009, this region could suffer as ground zero of a potential outbreak. Unlike many ETFs that focus solely on the South African market, AFK offers more diversified exposure to the continent's economies.

Disclosure: No positions.

Comments

[zzhcct:]

seriously, could your tell me the source of "a serious threat to eliminate 80% of the world's most widely grown crop"

Jun 19 05:50 AM

[megiddo666:]

He's quoting a June 14, 2009 LA Times article by Karen Kaplan. The LAT article is a fairly decent piece of research, especially highlighting US wheat vulnerability. There are a couple of issues I'd take with this piece, however.

First of all if there is a major outbreak of Ug 99, wheat stem rust in Asia, it might be better to use DAG to maximize your return.

Second, AFK would not be an effective investment vehicle. The African countries are already affected, such as Uganda and Kenya, and the ETF would likely drop as ecnomies are further impacted.

Also, one needs to add Eritrea to the list of Ug 99 infected countries.

Finally, El Nino's potential impact on Australian grain production, and that of India and Pakistan may have a more immediate impact on crop yields/grain supplies than Ug99.

Jun 19 06:03 AM

[GregGH:]

Canada is in a drought for a large wheat growing area ...

www.theglobeandmail.co.../

More fuel for the fire?

Jun 19 09:47 AM

[LoneRngr:]

something interesting to keep an eye on but the markets don't seem to care. wheat traded over $12/bu last year, today it's $5.87/bu and recent price gains pale in comparison to soy's rally. If Ug99 is a serious near term threat someone forgot to tell the markets...

Jun 19 11:15 AM

[Mad Hedge F...:]

How about a block of black swans? The harvest for spring wheat is in full swing and the weather has been great, both here and in India, so prices have dropped $1.00 from the $7.25 top it put in two weeks ago. You usually see peak production in June, so this is traditionally a timely window to put on medium term long positions, as cash strapped farmers hedge known inputs. New plantings are down 25% in Argentina, and 18% in Canada. A multiyear drought continues in Australia, where my younger sister, unable to coax life out of her 7,000 acres near Esperance, has resorted to driving a huge Caterpillar truck at the ore mines up North to make ends meet. It’s just a matter of time before the food riots resume. For the raging long term bull case for wheat see www.madhedgefundtrader.... There is maybe $1.00 of downside here if we get perfect weather, but a possible double on the upside, and more if we get lucky. This is the kind of risk/reward ratio I am constantly hunting for. Wheat is one of the few Ag plays that is not overbought right now.

Jun 19 11:52 AM

[Mad Hedge F...:]

Here's another reason. There is a new fungus out there called UG 99 which has the potential to wipe out 80% of the world’s wheat crop. It has been doing damage to crops in Africa for the last ten years, and if it escapes to Asia, where wheat is a major part of the diet, the results could be disastrous. Sygenta (SYT) is the world leader in producing the fungicide for this particularly nasty form of wheat rust, and has already seen its stock double over the past eight months. Unfortunately, ridiculous European fears about genetically modified crops and “Frankenfoods” have discouraged further research in the field. There is no money in wheat, so companies like Monsanto and Du Pont focus their attentions on rice, soybeans, and canola, which see more processing and are therefore less subject to the EC restrictions. Needless to say, if UG 99 makes it to Asia, or Heaven forbid, here, the effect on prices would be unimaginable. See the long term bull case for the grains at www.madhedgefundtrader.... There will be no food bailout. The Fed can’t print calories.

Jun 19 11:53 AM

[Larry House:]

It can't be a Black Swan if you are anticipating it. It may be impactful and serious, but a Black Swan is not expected or planned for. You do reveal a serious issue--thanks.

Jun 19 03:13 PM

[Lynn:]

I read about Wheat Stem Rust in May of 2008 and made the following notes. It reduces the number of seeds that wheat produces and can kill the plant. It crossed the Red Sea into Yemen in Dec 2007. It is currently spreading across Africa, Asia and, most recently, the Middle East. The fungus could spread to the US within 5 years.
It is dormant in the winter and revives in the spring.
On April 2, 2008 the Gates Fdn awarded a $28.6 million grant to Cornell University to combat Wheat Stem Rust. The "Durable Rust Resistance in Wheat" project will bring together 15 institutions from around the world to develop a wheat that is resistant to the stem rust threat.

Jun 19 04:26 PM

[Andrew Mickey:]

Thanks for the extra bit. Every incremental "problem" will only make this year's crop smaller than expected. Every month we get a new bit of bad news for this year's crop production, yet the market doesn't care. I'm buying all summer long.

It's a simple setup way beyond that "everyone has to eat" theory: tinyurl.com/agricultur...

Jun 19 04:47 PM

[mac123449:]

During the Depression farmers would plow under their crop to drive up the prices of what ever they happened to be growing or simply not plant an extra field. So in the cities you actually had alot of starvation during the 1930 yet overall demand for food was down from previous years the farmers might try the same thing this time around to drive up the price.

Jun 25 06:19 AM

[Mad Hedge F...:]

Here’s a follow up on my call to buy wheat yesterday (www.madhedgefundtrader...). There is a new fungus out there called UG 99 which has the potential to wipe out 80% of the world’s wheat crop. It has been doing damage to crops in Africa for the last ten years, and if it escapes to Asia, where wheat is a major part of the diet, the results could be disastrous. Sygenta (SYT) is the world leader in producing the fungicide for this particularly nasty form of wheat rust, and has already seen its stock double over the past eight months. Unfortunately, ridiculous European fears about genetically modified crops and “Frankenfoods” have discouraged further research in the field. There is no money in wheat, so companies like Monsanto and Du Pont focus their attentions on rice, soybeans, and canola, which see more processing and are therefore less subject to the EC restrictions. Needless to say, if UG 99 makes it to Asia, or Heaven forbid, here, the effect on prices would be unimaginable. See the long term bull case for the grains at www.madhedgefundtrader.... There will be no food bailout. The Fed can’t print calories.

Jun 25 09:34 PM

[newbietech:]

What about the major selloff in DBA today, June 30th? Why is this happening and how does this play into the long side investment thesis? Are we now suddenly expecting low soy and wheat prices or is this an effect of futures being rolled over?

Jun 30 12:28 PM