A falling dollar, food inflation and biofuel production have all been hot topics in the commodities markets as of late. Bull markets in corn and soybeans have remained in the headlines and could stay there for much of the year.
While the supply/demand balance may continue to favor bulls in those markets, wheat might not be playing the same tune. Supplies of wheat are more ample in 2011 than those of corn or soybeans.
Unlike corn and soybeans, whose exportable supplies are grown primarily in North and South America, wheat is truly a global commodity, grown in many countries both north and south of the equator. While weather issues in some of the larger producers spiked wheat prices last year, production is getting back on track in 2011.
In addition to supply, wheat is not fully sharing in the demand boom experienced by corn and soybeans. The growth of BRIC nations is bringing exploding growth of a new middle class that is rapidly adding meat it's diet. As soybean meal is a main component of many animal feeds, soybean demand has surged in recent years. Likewise in corn. In addition to animal feed, corn also now feeds a demand sector from the ethanol industry. The USDA estimates over 40% of the 2010/11 US corn harvest will be turned into ethanol.
Wheat is not used for biofuel production. And it comes in a distant third as an animal food.
USDA Projects Heftier Supplies in 2011
While wheat prices can and do still benefit from growing populations, potential inflation, et, it has not matched corn and soybeans in adding new avenues of demand. Secret #3 in The 7 Secrets to Option Selling is to know your fundamentals. In grains, there is no greater fundamental than the stocks to usage ratio - a figure that measures the amount of stocks available at the end of the crop year (September 1) vs. the projected demand for the upcoming year.
While the 2010/11 US stocks to usage ratio for corn approaches the 2nd lowest on record at 5.0% for 2011 and soybeans stocks to usage tumble to paltry 4.2%, wheat stocks to usage remain at a relatively hefty 34.2% for the year.
This is a primary reason why wheat has not tracked corn and soybeans as closely in their respective bullish ascents.
On a global scale, despite production setbacks in Canada, Russia and Australia last year, global ending stocks to usage at 27.6% in 2011 will still be far heftier than those of corn or soybeans.
These supply figures indicate that the wheat market will enjoy a more stable supply cushion to begin the 2011/12 harvest season than will corn or soybeans.
But those supplies are already, as they say, "in the barn." The market will now turn it's focus to growing season 2011. Weather, as always, will play a role.
New Crop Year
While weather concerns can pop up anywhere, the severity of 2010's problems are rare. More "normal" weather patterns are expected for much of the major wheat producing regions. Countries such as Russia are expected to lift export bans imposed last year as a result of domestic production shortfalls. India will begin exporting wheat for the first time in 4 years and is expected to harvest a record 84.3 million tons of wheat this year. Most importantly, however, is that wheat enjoys a much larger margin for error than does corn or soybeans due to it's healthy ending stocks. This should make it's price less susceptible to sudden surges than that of corn or soybeans. True, wheat will probably lose the acreage battle to corn and soybeans in the US this year due to their higher relative values.
Nonetheless, in a bullish or bearish overall environment, wheat will most likely perform as a "weak sister" in the grain and oilseed complex in 2011. This means she will lag corn and soy in a bull market and probably "lead the way" lower in a bearish reversal.
For the reasons listed above, we see wheat as an excellent hedge play for traders already short puts in the corn and/or soybean market. As a base option selling strategy, traders should look to sell deep out of the money puts in bull markets and deep out of the money calls in bear markets.
However, bull players who sell puts will often sell calls as well to take advantage of overpriced strikes far above the market (even if they think prices will continue higher.) This is especially true this time of year when grain prices often correct once planting is complete (in May or June). Our suggestion is that instead of selling calls in soy or corn, stay short the puts in these markets and sell your calls in wheat.
If bull market conditions continue, wheat calls will likely appreciate more slowly than those of corn or soybeans. In a corrective environment, their profit will likely offset any temporary pressure on soybean or corn puts. The object, of course, is to have all of them eventually expire worthless.
We will be working closely with managed accounts in the coming weeks to determine appropriate strikes and premiums in the wheat market.