The Grain Drain: 3 Reasons For The Current Wheat Shortage

by: Hard Assets Investor

As you walk by supermarket shelves stocked with loaves of bread and pasta, it seems hard to believe, but the world is currently experiencing a major wheat shortage. In the commodity markets, the shortage has helped drive the price of wheat to thirty year highs. According to the London-based International Grains Council, global wheat supplies in the year ending June 2008 will drop to their lowest levels in more than a quarter of a century. Meanwhile, the price of wheat is soaring. At the end of August, CBOT December wheat contracts hit a record high of $7.885 a bushel. Over in Europe, wheat for November delivery on the Euronext.liffe exchange reached 266.75 euros ($363) a ton in Paris. Prices for the contract closest to delivery have gained a whopping 75 percent this year alone.

As with most commodity price spikes, wheat prices are being affected by two dynamics: a shortage on the supply side and an increase on the demand side. Supplies have been hurt by droughts in Ukraine, Europe, Canada and Australia, which are four of the world's leading wheat producing. The U.S. is the world's #1 exporter, and U.S. farmers are churning away, exporting about 16.5m tons of wheat this year, almost double the amount they sold in the same period last year. However, a severe drought cut Australia's wheat crop last year to just 10 million tons, less than half the year before. Meanwhile, Ukraine, the world's eighth-biggest wheat exporter, is already cutting exports after drought cut its grain harvest to 30 million tons, its smallest since 2003. The country will ship 58 percent less grain this year, according to its Agricultural Ministry.

While sellers have less wheat to sell, buyers keep coming in with more orders. That's especially true in traditional emerging economies such as Brazil and India, but demand is coming from some surprising places, like South Korea, and Egypt. Egypt bought 10 times more wheat last month than it did a year earlier, in anticipation of higher prices, according to the country's General Authority for Supply Commodities.

There is a third factor affecting the global wheat market, and that is Russia, the world's fourth largest exporter of grain. Traders are speculating that the Russian government will step in and actively reduce shipments to control domestic food prices. According to Bloomberg News, Russia has created a ``working group'' to consider measures that may include export restrictions, duties and quotas. Kazakhstan also said it plans to introduce licenses for grain exports. The other part of the Russian wildcard is the country's elections, which take place next year. Russian President Vladimir Putin has to step down, and the USDA has said the election in Russia makes government policy, including possible tariffs or export regulations, less predictable than ever.

So how does a potential wheat squeeze impact investors? The price increases in wheat may incite fears of a spike in food prices, as the food industry begins to pass the cost escalation to the consumers. There is an ETF that tracks the Dow Jones-AIG Wheat Index, which trades in London under the ticker WEAT. It started trading in September 2006, and is managed by ETF Securities. WEAT is up 49% over the past six months and 63% over the past year. Price gains like that might give you pause. In fact, some traders are warning that the wheat market is over-bought and might correct in the next few weeks. After all, the U.S. continues to pump out huge supply, and from a fundamental standpoint, the first sign of rain in the skies over the Ukraine or Australia might send everyone to the exits.

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