The Wheat Debate

| About: PowerShares DB (DBA)

I have always found the grain markets a "great futures market." When I say that, I am talking about the people who operate within it, the price discovery that goes on and the knowledge that many of these traders have. Now, price discovery might be too nice, but the other two factors put these guys/gals near the top of their profession. Each time I have traded these markets, the broker on the floor has been more than willing to give me a little insight on the insanity that has been occurring. That insanity has included a wheat price spike in March and a corn/soybean price spike in July. These limit up and limit down moves have created enough heartburn that has caused a limit up move in Zantac to cure it. Thankfully, I have not been on the wrong side of a limit up move (or limit down move for that matter). Call it luck or whatever it might be.

Anyhow, I was discussing the grain market futures with a trader at the board and something struck me funny in the conversation. Iran has been a big buyer of our wheat this year (vs little or no buying last year). Yet, we sit there and argue with them about the nuclear ambitions. This tells me that perhaps we are not that serious about Iran and nuclear weapons - either that or the farmer in this country controls the decision making. Anyhow, aside from this, in our conversation, two things outside of this Iran news had me go back to my drawing board. First is the effect of a strong dollar and second is the Baltic dry index.

Let's start with the dollar. Historically, when the dollar has been overly strong, the grain markets here have been somewhat weaker than other commodities as globally our markets are just not as cheap as others who have weaker currencies. Over the past few weeks, there has been some very large buying of the wheat market. As I mentioned, Iran has purchased a sizable amount this year and Egypt was rumored to be in the market last week. (There was also talk that the Ukraine was buying but the US was left out.) So it appears at this point that US wheat seems to be competitive at the moment, regardless of the strong dollar.

Across the pit though, this is not the case. The soybean market collapsed Friday (products included) as demand is actually falling in that market. Rumors were floating around overnight that China had defaulted on a shipment out in the far east. This cause some oil futures overseas (palm oil) to sink aggressively and this spilled into our market. The strong dollar is not affecting things here but global demand is.

Global demand in this case can be best represented by the Baltic dry index which is having issues at the moment (it's cascading). The index is now approaching a trend line drawn from the lows in 2006 and has moved below a major moving average I use. The last time this occurred in January, the index reversed course and had a strong half year until its most recent decline. If the rumors of China's demise are starting to become more than rumors and the house of cards is about to fall, then what does that do for global commodities. Back to the original argument - what does that do for wheat?

Well, if we have a rising dollar and global demand is falling, our grains become much more expensive relative to other nations. This is deflationary in many ways and given the massive amount of money that has poured into the grain markets here in the US over the past few years (via futures, actual purchases of land, farms, etc), the effect could be tremendous to the downside. You saw limit down moves Friday in the beans - this could become more widespread if the Baltic dry starts to fall more aggressively. Rising dollar, falling demand - not helpful for US grains.

From the technical side, two things are working against the grain markets. First, there have been two major rallies this year with the corn/bean market and the wheat market. Both have been sold into heavily and as a result of the limit down moves Friday on the beans side, the charts are almost in line with each other (as you can see). Wheat has had a bounce of late on the back of the foreign purchases but given the weakness in the bean and corn side, I have to believe wheat starts to feel the pinch as well. Further supporting this case is the downward trend in the Grains ETF (NYSEARCA:DBA). It has rallied back to the 65 week MA but did not close above it Friday which makes it ripe for a reversal next week with another sell off to follow.

So my outlook on the grains is this: I remain bearish on commodities in general. As for the grains, the DJ AIG grains index failed a few months back at the 1995 lows. If it has taken the 91 level convincingly, we could have been on the verge of a major rally push up another 20%. This would have been bullish for the whole grains complex - conversely, I think this would have really hurt the dollar. Now with this failure, one could make a case that the short side of the trade is in and downward prices are what to look for going forward. Thus, I am bearish on the wheat and grains as a whole.

Disclosure: I do not have a position currently in any securities mentioned.

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