Wheat Class Substitution Fuels Arbitrage
The sweeping nature of this summer’s price declines in grains and oilseeds has at every moment been dependent on unusual season-long consistency of rainfall and below-average temperatures. Owing to many years of observing sudden weather changes generate wrenching turnarounds in direction of futures, the managers felt that committing to price direction was tantamount to forecasting weather. Monthly returns remained flat, but the two successful trades were strategies formulated to end-run weather risk.
One was an arbitrage between two classes of wheat whose prices had reached an historic wide mark as a result of drought slashing production of the one, and competition from Russian wheat the other. The record discount of soft red winter wheat, used for cookies, crackers, and cakes, to hard red winter, the primary breadstuffs ingredient, created incentive for marginal substitution of the cheap soft for the scarce, high-priced hard. This narrowed the price relationship between the Chicago and Kansas City contracts.
An unexpected factor – one “expects the unexpected” in this business – is that excessive rain just ahead of harvest damaged a large portion of the soft wheat in major producer France, boosting price prospects for its U.S. counterpart. The price of wheat unfit for milling declines to that of feedgrains, for which it is an excellent substitute. That in turn forces Ukrainian corn away from the E.U. to further abroad in search of customers, reducing U.S. export prospects. The U.S. corn crop should encounter other extraordinary demand deficiencies, especially problematic because volume is expected to be record-large. So the “sea change” discussed in last months’ market commentary looks to be deeper for corn than it appeared earlier.
As if the above isn’t a tangled-enough web, the financial problems of Argentina and geopolitical ones of Ukraine, each a major U.S. competitor, have intensified. In both cases the question of whether future grain production will decline is difficult to discount. It can be stated with fair certainty that a price decline of the magnitude experienced by corn over the last year will by itself result in reduced production everywhere, including the U.S. That prospect is likely what will bottom corn prices this fall.
Outstanding (unshipped) sales of U.S. soybeans and soymeal are together a record-large volume, but farmers have done little pre-harvest marketing. This may offer spreading opportunities over next several months, depending on pace with which the sellers are able to cover their contracts. Soybean prices are far higher than corn, so farmers may procrastinate on corn liquidation until later in year, generating a different set of arbitrage opportunities. And we continue to find profits in inter- and intra-market wheat trades.