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PRUDENTIAL SECURITIES, INC.
One New York, New York, New York
(November 21, 1997) WHEAT: Wheat rallied more than 10 cents per bushel early last week, reaching as high as $3.48. Since then, it retraced all of those gains and made new lows that reached levels not seen since July. The rally basically initiated from two factors–a recent upturn in export business (although there was not much depth) and that the market was technically oversold. Fund selling and overwhelming bearish fundamentals stopped the rally in its tracks.
BEARISH FEATURES–Loose U.S. And World Balance Sheets: The November Supply/Demand report showed very comfortable world and U.S. projections. Even though U.S. ending stocks tightened fractionally from the October estimate, the stocks-to-use ratio remains large at 27.2%. This is the most comfortable stocks/use ratio since 1990/91 when it was 35.7%. The world stocks-to-use ratio is projected at 22%, which is the loosest balance sheet since 1992/93 when the ratio was estimated at 25.3%.
Large Deliverable Stocks: Total stocks in deliverable position against the Chicago contract are the second largest since 1982, and are mainly held in Toledo. Stocks in Kansas City and Minneapolis also are large, and well above comparable levels last year. The large stocks level should keep spreads on the defensive, especially in the front months as the respective first notice days approach. Indeed, carrying charges tend to build in years characterized by large supplies and growing deliverable stocks.
U.S. Winter Wheat Crop In Excellent Shape: U.S. winter wheat prospects look very good as the weather has cooperated nicely with planting, emergence, and pre-dormancy establishment. The latest crop index showed the U.S. winter wheat crop at 105.9% of normal, a level above last year's rating at that time–and Kansas produced a record hard red winter wheat crop last year.
Lackluster Export Pace Due To Stiff Competition: The world wheat trade is expected to top 112 million tonnes this year, down 4.5 million tonnes from last year's figure. Although the drop may appear unusual in light of an expected record crop of 603 million tonnes, a rise in supplies does not necessarily translate into increased trade in the wheat market. Instead, supplies of major importing nations make a better barometer. Ending stocks of major importing nations are projected to grow 6.0 million tonnes from last year's levels to almost 44 million tonnes this year. This certainly implies that importing nations might not feel as pressed to purchase world wheat, or at the least, will be content to wait for lower prices. Currently, the U.S. export pace is lagging compared to last year's activity, and this has been weighing on the markets.
BULLISH FEATURES–Chinese Winter Wheat Crop Still Too Dry Prior To Dormancy: The 1998/99 winter wheat crop has suffered from excessively dry conditions left over from the summer drought that wrecked China's corn crop. Chinese winter wheat is grown in roughly the same area as corn, and soil moisture levels are very low. Additionally, it seems that chances are poor that soil moisture levels and reservoirs used for irrigation will recharge this year.
Short-Term Export Pace Picking Up: The most recent weekly export sales figure of 392,000 tonnes was 10,000 tonnes above that needed to make the USDA projection of 1,075 million bushels for 1997/98. If this pace continues, then U.S. wheat exports will surpass the USDA's goal. However, stiff competition in the world wheat trade makes that likelihood anything but certain. Year-to-date export sales total 18.4 million tonnes versus 19.0 million last year at this stage.
SWING FACTORS–Southern Hemisphere Crop Prospects: There is risk to southern hemisphere crops as harvest approaches. However, Australian harvest prospects probably are not in as much risk as in Argentina, where excessive rain cannot be ruled out due to the ongoing El Nino. Nonetheless, there does seem to be a drier pattern emerging over the next week or so for Argentina.
Chinese Wheat Production: Chinese winter wheat areas have received beneficial rains, but more are needed for the crop to develop normally.
PRICE PROJECTIONS–For the short term, December wheat has a strong likelihood of testing contract lows at $3.34¾. The negative fundamentals are longer term in nature and probably will not change in the short term. We are content to stay sidelined for now, in search of fundamental rationale that would justify establishing a long position.
Longer term, the overall wheat situation is bearish for several reasons: (1) comfortable U.S. and world supply/demand balance sheets; (2) the potential for rising U.S. ending stocks, perhaps resulting from lower-than-expected exports; (3) relatively ample wheat supplies in Australia, Canada and Argentina; and (4) the European Union's ability to subsidize wheat sales.
At this point, we do not see a need to step in and take long coverage. But if hedge policy dictates coverage, then look to March call options. These options should be the cheapest on the board, and if prices do decline to lower levels where long positions in futures look attractive, then regard the loss in the call option as cheap insurance.
Tom Levis
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