The Fundamentalist Point of View:
The wheat market is currently trading at historical highs, and most analysts agree that the market will continue to trend higher. Wheat futures in Chicago touched $11 a bushel for the first time in history, after the U.S.D.A. reported that the U.S. crop will be at its lowest inventories in 60 years! In the week of February 4th, 2008 prices gained 16%, the most ever, and prices have more than doubled in the past year! The Chicago exchange doubled its daily limit after prices gained the previous maximum of 30 cents for five straight days. The U.S.D.A. expects U.S. stockpiles to drop to 272 million bushels at the end of May 2008, 6.8% less than expected a month ago and down 40% from 2007. This means that inventories will be the lowest since 1948 when farmers grew less and shipped more wheat overseas to help rebuilding countries after World War II according to economists. The USDA predicts, “World inventories of all wheat are expected to fall to 109.7 million metric tons by the end of the marketing year on May 31, down 1.1% from a January estimate and the lowest since 1978.” The low global inventories are a result from weather damage in some of the world’s largest producing countries including the U.S., Canada and Australia. Rising food consumption in China and increased demand for corn and soybeans used to make alternative fuels also are eroding global crop supplies, as many farmers shifted acres to these commodities and away from wheat.
The high prices of wheat not only have an effect on traders, but greatly influence businesses and corporations worldwide that depend on the grain. Bloomberg reported that because of wheat's unprecedented rally in early 2008, many companies may have to raise costs of their products, including Kellogg Co. and General Mills Inc., the largest U.S. cereal makers. Higher food prices are also stoking inflation, increasing social tension in developing countries and making it difficult for central bankers to spur economic growth by cutting interest rates. “There isn't enough spring wheat to meet ongoing shipment demands of Asian customers,” said Simon Roberts, head of agricultural commodities at Australia and New Zealand Banking Group Ltd. Prices gained 16% last week, the most ever, and have more than doubled in the past year. Buyers also increased purchases on speculation farmers wouldn't harvest enough to meet needs and to curb rising food costs. Goldman Sachs Group Inc. raised its three-month wheat forecast by 47% and its six-month estimate by 35%, reflecting ``near-term tightness'' in supply. Both estimates were increased to $13.50 a bushel, said the New York-based bank in a report dated Feb. 8. In addition, India, the world's second-largest consumer of the grain, may import 68 percent more this year, said Mark Samson, vice president for South Asia at U.S. Wheat Associates, a government- and producer-funded trade advocacy group. USDA data shows that India imported 6.71 million tons in the year that ended on May 31 and is expected to buy 2 million tons in the current marketing year.
There is a possibility that wheat’s recent high prices may attract farmers to begin to devote more acreage to the crop. Recently the market has been consolidating, waiting for further news on acreage. U.S. farmers might plant 3.6% more acres this year. Globally, there is a possibility for 4% more wheat acreage. Even with these increased planting figures, global inventories will still be low. The U.S.D.A. still expects that global inventories will be at 109.7 million tons for the year, which will be a 12% drop from the prior year. U.S. stockpiles are expected to fall to 272 million bushels, which would be the lowest level since 1948.
The Technicians Point of View:
There are several technical indicators pointing to the possibility that wheat will continue on its impressive bull rally. One of the simplest indicators investors and traders use is called support and resistance. Looking at a daily historical wheat chart, you will notice that wheat recently broke through short-term resistance at $9.79 a bushel. Soon after the market broke through the resistance, the wheat market behaved as a technician would have predicted, it made a strong movement to the upside. In fact, the market settled above the next resistance which was a psychological resistance of $10.00 a bushel. The next three days made history. Wheat traded above $11.50 a bushel! This movement was highly profitable for few, but mostly short lived. Last Monday (February, 11th), the market sold off and gave back all the ground it made and then some. However, it did not break through the new support that was created after wheat made the break out. When a market breaks through resistance, the resistance then becomes the new support, and in our case, it’s $ 9.79. The fact that it held strong and didn’t break through support and the market traded above $10.00 a bushel, indicates to me that this market may have the strength it needs to make new all time highs!
Another technical indication the market maybe continuing to make new highs is the Relative Strength Indicator (RSI) and Bollinger Bands figures. A market is technically overbought if the RSI is above 70. In our case the RSI reads 59.05. Meaning the market is feeling the buying pressure, but is certainly not overbought, yet. It’s important to note that a market may have an RSI that reads over 70, but the market is not overbought, instead the market maybe trending upwards. Look at figure 1.0, between June and September of 2007, the RSI made several advances past 70 yet there was no major sell offs or consolidation periods. This is because the market was trending. Another indicator that doesn’t work during trending markets is Bollinger Bands. Typically, traders will use Bollinger Bands to find the highs and lows of a market. If a market, like wheat, is trading at or above the top band, then the market is said to be peaking or at its highs. Notice the wheat chart. Wheat blasted clear past the top band, but could not hold on for long and traded back in between the bands. Recently, the market brushed against the 20 day moving average for the Bollinger Bands, which for technicians means that the market appears to be strong, and subsequently wheat turned toward higher prices.
The technical analysis concludes the wheat has recently experienced an influx of buyers, thus pushing prices too high, too fast, but after it blew off steam, the wheat market is ready to continue on its impressive rally and maintain its title of the commodity of the year for 2007 well into 2008!
Figure 1.0
The Trade
I feel that the technical and fundamental aspects of the wheat market indicate that higher prices are more likely than not. To capitalize on the analysis I have compiled a very low-risk strategy that traders can use to take advantage of rising wheat prices.
Notice:
It is well known in the commodity industry that the grain sector can be highly volatile. In the event that the wheat market pulls back well below the support level, traders can easily protect themselves to the downside by purchasing a cheap, out of the money put in either July or December contract months.
Trade Recommendation:
July Wheat Bull Call Spread:
Buy 1000 call and Sell 1040 call for 14 points
Cost: $ 700 + commission
Profit Potential: $ 1,300
Total Risk: $ 700 + commission
July Wheat Put: (Protection)
Buy 630 put for 5 points
Cost: $ 500 + commission
Profit Potential: unlimited
Total Risk: $ 500 + commission
Summary:
The fundamentals supporting the wheat market are unprecedented. Wheat has been a frontrunner in the current bull rally in commodities and we believe that the market still has a remarkable amount of upside potential. I feel that this is a market that traders should be diversified in to for their 2008 portfolios!
