One of the most consistently reliable indicators of the direction of price movement in the futures market is the price spread in future’s contracts as you look forward in time. Basically, as long as the price spreads between the different futures contracts remain stable, the direction in which prices are moving will remain the same, but when the spreads begin to collapse, the market is starting to change direction. It’s an important detail to notice for Ontario grain producers right now because those big price spreads which we’d seen in wheat futures for the past 5 months of deteriorating wheat prices are collapsing, and it means that wheat prices are putting in a bottom and are about to turn around.
One easy way to visualize futures spreads is to think about the futures market as if it were an escalator. Each of the futures contracts is a different step on the escalator, (December, March, May, July, etc.), but they organize in a rational price order. Typically, each month going forward is at a higher price in order to reflect the cost of storing the commodity for a later delivery. The reason that spreads work as an indicator of price movement is because the “spreads” or the height of those escalator steps shrinks as the market starts to reverse its direction of travel.
Since the wheat market peaked in price in the first days of August, the Chicago December wheat futures price dropped $1.20 per bushel, or more than 20 % of its value, from a close of $6.20 on August 2 to closing at $5 on October 31st. The reason that it stops dropping is because at some point the marketplace simply runs out of people who are willing to sell it any cheaper. Any sales that need to be made take place further forward in a higher-priced futures contract, and the spreads between the different months tighten. The same thing happened in late June and early July when the big pre-harvest rally in wheat prices ran out of speculators who had enthusiasm to keep buying the highs, and now we’re bottoming out the trough because there simply aren’t reasons to continue to sell the low. A turnaround in wheat prices is clearly underway.
By the time that we hit the close of trade on November 9, the December ’18 Chicago wheat contract settled at $5.02, and the September ’19 Chicago wheat futures contract settled at $5.37. That means that the futures market is only prepared to pay commercial hedgers $0.35 per bushel to store soft red wheat for the next 10 months (less than half of what it was in July). Three-and-a-half cents per bushel per month is far less than the cost of carry and a very clear signal to commercial basis traders to dump wheat. Their business model relies on the carry in the futures market to finance the storage and interest on stored wheat inventory, and it clearly isn’t there anymore. Commercials who sold the carry months ago won’t need to adjust their strategy, but for the few that kept their short position in the front month, this might get uncomfortable.
Farmers who grow wheat are ultimately flat-price sellers. The early signals of a turnaround in wheat futures prices is both welcome news, and long overdue. If for no other reason than technical retracement, there’s room for a $0.50 to $0.60 rally in Chicago wheat futures to unfold in the months ahead.
In addition to the bottom, clearly forming in the wheat futures, there are several other considerations which Ontario winter wheat growers should be watching as they size up the price potential for any remaining 2018 crop wheat. After a wet October, there is no shortage of questions regarding how much winter wheat has actually been planted. What sort of soil conditions did it go into? And why do germination and emergence seem to be taking so long? Concerns about crop conditions before winter only heighten the anxiety over winterkill as we transition out of dormancy next spring. There’s a lot for wheat market watchers to worry about and “buyer’s worry” generally translates into better prices for sellers.
There’s also a lot of interest in whether wheat becomes part of the livestock industry’s solution to maneuvering through a year where part of Ontario’s corn supply is compromised with vomitoxin levels. While risk mitigation strategies are still being developed, there is certainly no reason to believe that this province will feed less wheat in the year ahead, and reasonable grounds to assume that we will feed more.
What we’re watching right now with spreads in the Chicago wheat futures is the price boomerang making the arc in its flight where it turns around and starts to come back. Patience is now on the farmer’s side.
Steve Kell operates a crop farm in Simcoe County and is a grain merchant for Parrish and Heimbecker Ltd. in Toronto.
