India: Drowning In Subsidized Wheat

Includes: EPI, JJGTF, WEAT
by: Peter Pham

India is all set to export three times more wheat than was expected this year, a record 6 million tonnes, thanks to a bumper crop. While this won't make much of a dent in overall market structure with exports falling worldwide it will help to counterbalance the scarcity of lower quality grain supply and keep global prices controlled at the margin.

The Indian government recently allowed exports of 2.5 million metric tons of wheat from overstocked government store-houses. The revised limit is an addition to the 2.0 million tons earlier cleared for exports.

India's farming sector is thriving with bumper harvests of wheat for five straight years. This has created large stashes of wheat domestically when countries like Australia and Russia which are the world's second and third largest exporters, respectively, are facing declining production due to adverse weather.

Although the amount of wheat India will export is not much compared to the 140 million tonnes global export market, it will help settle India's balance of trade as the government will finally begin selling off its, frankly, excessive grain stores.

The supplies of wheat all over the world will further shrink after the declaration by U.S. president, Mr Obama, to mark wide parts of the central and southern wheat belt as a disaster area due to continuous drought. U.S. farmers are contending with the worst drought in 50 years which has sent wheat prices soaring to $900 per tonne last summer. Currently, U.S. wheat is still more than 350% higher than wheat futures in London. The Teucrium Wheat Fund (NYSEARCA:WEAT) is an ETF designed to track the futures price of wheat on the COMEX, holding nearly equal weighting in the 9 month forward futures contracts for those interested in trading wheat without the leverage of the futures exchange.

In 2012, wheat came out as the best performing commodity, rising by 19.2% among the 19 commodities in the Thomson Reuters-Jefferies CRB index. The rise in the price of wheat was due to the lower production in Australia and the Black Sea region and lower expectations coming out of the U.S.

This year's bumper harvest of wheat in India corresponds with the shrinking shipments from its main competitor for lower-quality wheat. The price in India is cheaper by $20 per tonne as against similar Australian grain. And if the government would push out hoarded storage that is inadequate the spread would likely increase.

Hoarding to hold out for better prices is a game that is played in Vietnam and has gotten a number of people up and down the exporting chain in trouble. We saw this in rice and coffee last year in Vietnam and the Indian government is doing the same thing here while it protects its subsidy of Indian wheat farmers.

In Australia record yields were produced at the end of 2011, but its quality was reduced by heavy rains. After a year, wheat production declined by more than a quarter due to dry weather, while drought is also expected to reduce the number by half for Russia's wheat exports this year to 10.5 million tonnes.

The world's second biggest wheat producer, India generally consumes the majority of its crop but this year government intervention and encouraging weather have enhanced production and surpluses. In the last year, wheat production increased to a record of 93.90 million tonnes while consumption remained static at approximately 76 million tonnes.

The crop production for this year is projected to be even bigger, which will certainly be another challenge for the state procurement agency, the Food Corp. of India who has resorted to storing wheat in open fields under tarpaulins as silo space is negligible, wasting what should have been a valuable export.

After years of this behavior, FCI has finally been prodded to do something different and recently announced it was sending a delegation to study wheat exports with international wheat buyers in Singapore and Australia. The visit, hopefully, is expected to help the food agency to clear its choked warehouses ahead of the new harvest in April. The mix of ineptitude and lack of bureaucratic incentive until the waste was embarrassingly made public is stunning and a classic example of the economic law that subsidizing something creates more of it. So, wheat production is stimulated by government largesse and likely over-paying for the crops which incentivizes the farmers to plant more wheat while the crop builds up in inventory because the world market price is below the government's carry costs on the supply.

Now faced with stocks of 34.4 million tonnes, which is three-times greater than the official target of 11 million tonnes, and an estimated record 40 million tonnes of wheat incoming starting in April which it is expected to buy from local farmers, they are trapped. The 6 million tonne figure sounds like a big increase but more could be done if the internal infrastructure was there. Again, this is a classic unintended consequence of subsidizing one thing leading to shortages of something else.

They will have to sell much more than the 250,000-300,000 tonnes they sold in December to offset the oversupply. It's not like India is alone in this. Government intervention into food production is par for the course worldwide. Commodity investors could look at various ETFs to play this year's drought and currency wars story. iPath Dow Jones UBS Grains Total Return Sub-Index ETN (JJG) has performed substantially better than the WEAT since the beginning of 2012. In fact WEAT has somehow managed to lose 7.5% since late December 2011 while JJG is up more than 20%.

As for India, I continue to like the WisdomTree India ETF (NYSEARCA:EPI) for exposure to a country that is no stranger to odd policy decisions and looks to be on the other side of the worst of the current policy blunders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.