The Ultimate Guide to Wheat Investing

by: CommodityHQ

By Eric

Wheat is one of the oldest and arguably the most important crops in the world, primarily responsible for man's movement to the cities in ancient times. The crop is relatively easy to grow, can flourish in a multitude of environments and the crop tends to stay fresh for a long time, allowing food to be stored for a long-period. Today, wheat is one of the three most consumed grains in the world, second only to rice in terms of human consumption at just over 680 million tons a year.

Increasing populations and developing economies have contributed to an ongoing increase in food demand, thus broadly raising the prices of most agricultural commodities over the past few years. Due to its high nutritional value and since it is a good source of protein, wheat looks to remain an important crop to feed the billions of people in the world for years to come, especially as more corn is diverted to animal feed and ethanol and away from human consumption. Additionally, since rice is very labor intensive and requires ample water to grow, wheat could see a resurgence in nations seeking higher crop yields without the issues that are present in the other major grains.

Physical Properties and Uses Of Wheat

The majority of the crop is used in human consumption, ranging from cereal and bread, to pasta and even beer. Unlike corn, wheat is primarily used as food and doesn't find its way into biofuels or livestock feed nearly as much as its yellow cousin. As a result, wheat is grown primarily to make a high quality flour for baking bread in countries around the world. Wheat's growing season is generally agreed to be about 100 days, making it a relatively quick growing crop when compared to other soft commodities.

While wheat is grown all over the world, various types of the grain are better suited to certain locations. Each type of wheat -- hard red, soft red, durum and white, requires slightly different climatic conditions for growth which is why we see differing varieties in different countries. The most prevalent class of wheat grown in the Untied States is hard red winter wheat. This type is grown predominantly in Kansas, Nebraska, Oklahoma and the Texas panhandle. The cold, sub zero winters and the general lack of precipitation make these regions of the country ideal for hard red winter wheat production which is primarily used in bread making. Meanwhile, soft red winter wheat is grown in more diverse areas of the country, ranging from central Texas, towards the Northeastern Great Lakes and east to the Atlantic. Soft red wheat is generally grown in more humid environments, not suited to hard grain production. The flour from soft red winter wheat is used to make cakes, cookies, snack foods, crackers and pastries. Lastly, hard red spring wheat is grown in the Northern Plains states where the winters are too severe for winter wheat production, but the rich black soil and the dry, hot summers make it ideal for this type of spring planted crop. The major producing states are Montana, Wyoming, North and South Dakota, as well as Idaho, while Canada also tends to produce this type as well. This high grade wheat is suitable for milling and used primarily in breads.

Wheat Supply and Demand

Wheat is produced on every continent around the globe except for Antarctica. The crop is extremely popular in India, parts of Australia, Eastern China, the great plains of North America and the vast majority of Europe.

The top producers, in million metric tons, are highlighted below:

Country 2009 Production
EU-27 138.7
China 115.0
India 80.7
Russia 61.7
United States 60.3
France 38.3
Canada 26.5
Germany 25.2
Pakistan 24.0
Global Total 681.9

In terms of exports, the list is slightly different (once again numbers are in million metric tons):

Country 2010 Exports
United States 35.4
EU-27 21.5
Canada 17.5
Australia 13.5
Argentina 8.5
Ukraine 5.5
Kazakhstan 5.0
Russia 4.0
Turkey 3.0
Brazil 1.1

Wheat Price Drivers

Although the price of wheat is heavily correlated with the performance of the grains group as a whole, it still bears its own unique characteristics that impact its price movement. There are several factors that can impact the price of wheat which we have outlined below:

  • Strength of U.S. Dollar: The United States is a top exporter of wheat so the dollar's value tends to play a key role in impacting the demand and price for the staple grain. When the U.S. dollar depreciates, net exports from the USA tend to follow suit, but since much of the wheat is produced in Europe and Asia and wheat is quoted in dollars, a decline in the dollar's value may increase prices as well.
  • Government Regulation: In an effort to make sure that citizens of their own country have food, sometimes governments ban exports of staple crops abroad. When Russia experienced large fires and weather related problems, the country shut off its exports of the key crop driving prices higher. This could happen in any number of countries if a similar weather issue takes place, adding to the risk for those on the short-side of a wheat trade. Additionally, one must also consider government subsidies as well. If these cash payments to farmers who grow the crop cease or are significantly curtailed, farmers could shift to other crops instead, potentially increasing the price for wheat as well.
  • Emerging Market Demand: Rising fertility rates in Southern Asia, Middle East and Sub-Saharan Africa are contributing to an ever increasing demand for food, simply because our world population is growing as a whole. Wheat is a hearty grain that has a multitude of uses and can be grown in a number regions making it a popular choice for governments looking to feed large numbers of people so supplies could surge as demand rises for the crop. Another factor that must be considered is the rapid increase in incomes of people in these countries and the likely demand for meat out of these nations in the near future. Extra grains will have to be produced to create feed in order to beef up the meat supply, potentially creating higher demands for grains once again.
  • Weather Conditions: The most basic price diver with any commodity is supply and with wheat, weather is the underlying variable that impacts production. Extremely wet or dry weather conditions hurt harvest yields and can cause price spikes due due to the tightened supply. Likewise, favorable weather conditions could result in abundant yields, causing supplies to increase and price to fall.
  • Demand for Ethanol: Recent research shows that rising demand for ethanol took up to one-third of the United States' corn output in 2008, significantly straining the market. Thanks to generous government subsidies and the high price for oil, many farmers are cycling their crops to corn in order to take advantage of this boom. One of the main casualties of this has been wheat which has seen its acreage fall when compared to corn. Should these trends continue, it could push up the price for wheat significantly, especially if the USA, the world's top exporter, sees its supplies of the grain dwindle in the coming years.

Investing in Wheat

Wheat may have appeal as an investable asset for several reasons. As a staple crop, wheat is an important part in our everyday lives and is used in a variety of food products ranging from breakfast cereal to the evening beer. Commodities in general are also an attractive asset class in an inflationary environment, serving as a hedge, while further demand from emerging markets could also drive the price of wheat higher, making an investment in wheat an intriguing choice.

There are a decent number of options for accessing wheat, including futures, stocks and even ETFs:

Wheat Futures

Wheat futures are traded primarily in two places; on the Kansas City Board Of Trade and the Chicago Board of Trade. Contracts at the CBOT trade under the symbol W between 10:30-2:15 EST in lots of 5,000 bushels. The contract's expiration dates are in March, May, July, September and December and the last day of trading is the last business day prior to the 15th calendar day of the contract month. Futures contracts are subject to the daily price limits and exchange rules of CBOT. Meanwhile, at the KCBOT, trading here represents the world's largest free market for hard red winter wheat. A KCBOT wheat futures contract consists of 5,000 bushels of hard red winter wheat. The contract is for wheat graded No. 2 according to government standards. The wheat can be delivered in Kansas City or in Hutchinson, Kansas, in March, May, July, September and December. The crop can also be delivered to Salina/Abilene and Wichita, Kansas at price differentials. Hard red winter wheat accounts for around 45 percent of total U.S. wheat production and total U.S. wheat exports, it is a higher-protein wheat than its ‘soft' cousin and due to this it often trades at a premium to the wheat futures at the CBOT.

Wheat Stocks

Gaining exposure to wheat in the equity market is rather tough to do. There aren't any publicly traded wheat producers so investors must obtain exposure to the industry through agribusiness companies instead that have smaller levels of exposure to the sector. Below, we highlight a few possible choices in this respect:

  • Bunge Limited (NYSE:BG) and Archer Daniels Midland Company (NYSE:ADM) are global agribusiness companies involved in the production and sale of agricultural commodities. Much like metals mining companies, these corporate farmers have relatively fixed production costs and their profitability is linked with the prevailing market price of crops to an extent. However, keep in mind that these companies have tremendous diversification across international markets and product lines (edibles and industrials) and likewise their performance is not always perfectly correlated with the price of wheat or other grains.
  • Mosaic Company (NYSE:MOS) and Potash Corporation of Saskatchewan (POT) are manufacturers of fertilizer and if wheat demand increases, farmers will require more crop nutrients to improve harvest yields.

Wheat ETFs

Currently, there aren't any pure-play wheat ETFs available. However, there are a few products that offer exposure to the broader grain market and thus have heavy exposure to wheat. The two choices that investors have in this respect are:

  • iPath DJ-UBS Grains TR Sub-index ETN (JJG)

Both of these funds offer direct exposure to grains through an exchange-traded note structure. Both have significant allocations to wheat futures although JJG is much more liquid and is likely to be a better play for traders seeking high levels of volume.

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