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WHEAT QUARTERLY OUTLOOK
Prepared by Prudential Securities, Inc.
The wheat market will not be taking the spotlight away from corn this year because both the world and U.S. supply/demand balance sheets are not nearly as tight as those for the yellow feed grain. The world wheat balance sheet shows a stocks-to-use ratio of 22%, nearly double that of the world corn situation. In the United States, wheat stocks are nearly three times as plentiful as corn in relation to usage, with the wheat stocks/use ratio at 27.2% versus the corn projection of 10.0%.
World Wheat Supply/Demand Situation
The world wheat supply/demand balance is far from tight. The USDA is projecting record production of 603 million tonnes in 1997/1998, up from the previous record of 588 million set in 1990/1991. Even though demand is projected to reach a record 583 million tonnes, ending stocks are expected to increase 20 million tonnes versus last year, reaching 128.5 million tonnes. This is the largest carryover since 1993, when ending stocks were 143 million. Similarly, the stocks/use ratio is expected to grow to 22% from 18.7% last year to reach its highest level since 1993 when it hit 25.3%. The world wheat market is very comfortable with 2.6 months of usage available as ending stocks, a situation that is hardly price friendly.
Australia
Australian wheat has made an amazing comeback from earlier projections that the El Nino would ravage the crop. Some estimates (ours included) were as small as 14 million tonnes 45 days ago. Now, however, the expected negative impact from El Nino has been largely mitigated due to timely rains in late September and October. The USDA currently projects 1997/1998 Australian wheat production at 17.5 million tonnes, up from its lowest estimate this season of 16.0 million.
Some private trade estimates have estimated Australian wheat production as high as 18.0-18.5 million tonnes. These are impressive numbers, considering that this is the strongest El Nino on record and that there is a strong correlation between El Nino events and Australian wheat production shortfalls. The greatly improved prospects for Australian wheat production have spurred larger export projections as well. The USDA projects that Australia will export 13.0 million tonnes versus previous estimates as low as 12.0 million tonnes. Also, if eventual Australian wheat production is truly 18.0-18.5 million tonnes, then expect to see exports rise above the current projection of 13.0 million tonnes by another 500,00 tonnes or so. This development would reduce 1997/1998 U.S. wheat export opportunities as well.
Argentina
Argentina is projected to produce 12.7 million tonnes of wheat in 1997/1998, according to the USDA, while private estimates suggest that the crop could reach 13.0 million tonnes; our estimate is 13.4 million. Now, with the wheat crop maturing, a tendency toward drier weather is considered optimal and recent weather patterns and short-term forecasts have fallen in line. Although not a problem currently, excessive rains could hurt the quality and/or quantity of the Argentine crop as it continues to mature. The USDA currently projects 1997/1998 Argentine wheat exports at 8.7 million tonnes. This is down sharply from last year's exports of 10.5 million tonnes, but production of 16.1 million tonnes then was much higher. At this point, it is premature to suggest that Argentine wheat prospects could be reduced due to large amounts of rain, but El Ninos are noted to produce an excessively wet pattern for this area.
Canada
There was little change in the Canadian wheat balance sheet in the USDA's last report, and not a lot is expected in upcoming forecasts. The USDA projects that Canada will produce 23.5 million tonnes of wheat for 1997/1998, with exports reaching 18 million tonnes. These estimates are not new to the market, but continue to exemplify the amount of competition for world wheat trade. The resulting stocks-to-use ratio is a fairly comfortable 25%.
China
Chinese wheat production in 1997/1998 was huge at 121 million tonnes. Although the USDA did not see fit to revise any estimates in the November report, China has a very comfortable wheat supply/demand balance. Ending stocks are projected to be the highest since 1984/85 at 33 million tonnes, and the stocks-to-use ratio of 29% is the largest since 1985/1986. As a result, Chinese wheat imports are projected to be the lowest since the 1970's. Typically, China imports wheat from the United States, thus U.S. export prospects do not look favorable.
However, the winter wheat crop--which is trying to establish growth prior to dormancy--has suffered from excessively dry conditions that wrecked China's corn crop last summer. Chinese winter wheat is grown in roughly the same area as corn, and soil moisture levels are very dry due to the summer's drought. Additionally, the chance of replenishing soil moisture levels and reservoirs used for irrigation is not strong as the country enters a time period that is normally rather dry. This situation could become a longer-term friendly feature, but not before U.S. wheat futures suffer from short-term bearish fundamentals.
Other Features
Besides showing a rather comfortable level of ending stocks and stocks-to-use ratio, the world wheat balance sheet reveals other significant features. Notably, the European Union has demonstrated a willingness to subsidize wheat exports when it suits its objectives. This year it has not yet aggressively subsidized sales, but the general feeling is that it will happen. When this occurs, competition for U.S. wheat increases significantly. The USDA projects that EU wheat exports will reach 33.2 million tonnes in 1997/1998.
Additionally, total supplies are expected to rise 7%, or 14 million tonnes, as major wheat importers are expected to carryin an additional 2.0 million tonnes versus last year and produce 12 million tonnes more wheat. Imports into the major importing nations are expected to be down marginally, but exports out of these same countries are expected to nearly triple, thus adding 2.25 million tonnes of wheat to world trade. The resulting stocks-to-use ratio would increase to 23% versus 19% the previous year. These statistics do not paint a picture of a year in which nations that are not self-sufficient in wheat will be in desperate need of the grain. A notable region for wheat exports should be Eastern Europe. The USDA projects this area will export 2.9 million tonnes versus 650,000 tonnes last year. Everybody has wheat for sale!
U.S. Wheat Supply/Demand Balance
The U.S. wheat balance sheet is bearish for prices because it is even more comfortable than the world supply/demand situation, even with a tightening in the November report versus the month-earlier estimates. As expected, the USDA made only a minor adjustment to the 1997/1998 balance sheet in its latest summary<197>food demand rose slightly to 910 million bushels from 900 million. In turn, ending stocks fell 10 million bushels to 655 million, which dropped the stocks-to-use ratio to 27.2% from 27.7%. Although ending stocks did retreat, the change was slight and still leaves a very loose balance sheet.
The USDA made just one minor change in the balance sheet for individual wheat classes, increasing food demand for hard red winter (HRW) by 10 million bushels and reducing ending stocks the same amount to 296 million bushels. The HRW stocks/use ratio remains a comfortable 31%. This upswing is a huge departure from last year, when the projected HRW stocks-to-use ratio was only 19%.
This year's huge crop in Kansas alleviated much of the tightness in HRW areas. Soft red winter (SRW) remains the tightest of all varieties, with a 14% stocks/use ratio, compared with hard red spring (HRS) at 39%, HRW at 31%, soft white wheat (SWW) at 20% and durum at 20%. With the exception of durum, ending stocks and stocks-to-use ratios for all classes of wheat have increased from last year's levels. Durum ending stocks declined 6 million tonnes and the stocks-to-use ratio declined three percentage points.
Potential U.S. Balance Sheet Changes
We expect to see the U.S. wheat feed/residual demand component rise slightly from the USDA's current 325 million bushel projection, perhaps closer to 350-375 million. Although this increase may not be quickly evident, the December 1 Stocks In All Positions report may encourage this adjustment to the residual. Food/seed/industrial (FSI) demand normally is stable, and any further changes should be minor and immediately assumed to be correct. Unlike the soybean crushing industry, there is no weekly survey against which to measure current projections, thus there is no solid methodology to adjust models in a timely fashion.
We also anticipate that U.S. export demand will be adjusted downward as the crop year progresses. This should not be a surprise because world wheat production is at a new record level of 603 million tonnes, and even the major importers are sitting very comfortably with stocks-to-use ratios of 23% versus 19% last year. Total world ending stocks are projected to be 18% above last year's levels. The USDA may opt to wait and see what the European Union does with refunds before slicing the U.S. export demand estimate; it may also want to consider weather conditions in Chinese winter wheat areas.
World adjustments that would affect the U.S. situation may include an increase in Australian wheat production by 500,000 tonnes to 1.0 million tonnes, resulting in a 500,000-tonne rise in exports to 13.5 million tonnes. The USDA could bump up Argentine production by 300,000 tonnes to 13.0 million due to favorable weather during the growing season, which would probably translate into 200,000 tonnes of increased exports. On balance, we do not expect to see a lot of change in the world wheat balance sheet, and the changes we expect probably would weigh on the bearish side for U.S. futures due to reduced U.S. export demand.
Other Bearish Fundamentals
Total stocks in deliverable position against Chicago contracts are the second largest since 1982, and the trend for receipts in Chicago and Toledo has been growing for several months. (Most stocks are in Toledo, site of the fastest growth.) Because the U.S. government is largely out of the grain business, the bulk of these stocks are grades that are available for futures delivery. The balance of the receipts (approximately 10%) are either not deliverable quality or ungraded; we believe the latter is true.
Stocks in deliverable warehouses for the Kansas City Board of Trade (KCBT) and the Minneapolis Grain Exchange (MGE) also are hefty. Total KCBT stocks top off at 45.2 million versus year-ago levels of a meager 11.0 million. MGE stocks total 13.4 million versus the comparable year-ago level of only 8.3 million bushels. Like the Chicago stocks, the vast majority of these supplies are deliverable grades.
The large stocks should keep wheat spreads on the defensive, especially in the front months as the respective first notice days approach. Also, carrying charges tend to build in years characterized by large supplies and growing deliverable stocks. These features are not typical of bull markets! Currently, the December-March spread is about 70% of full carry, while March-May is at 40% and May-July is 30%.
Another bearish feature is that U.S. winter wheat prospects look very good as the weather has cooperated nicely with planting, emergence and pre-dormancy establishment. The crop rating index indicates that winter wheat is likely establishing a good stand prior to dormancy, which will benefit the crop next spring when dormancy breaks. The latest crop index showed the U.S. winter wheat crop at 105.9% of normal, a figure that is above last year's rating at the same time. Last year, Kansas produced a record HRW crop.
The USDA will release the 1998/99 winter wheat planting survey around January 10, 1998. Some analysts already are expecting to see an acreage increase over last year. However, nearby wheat futures prices during planting this year were the lowest in five years; last season's large plantings were stimulated partly by relatively high prices during planting. At this early juncture, it seems that winter wheat plantings will be very close to last year's seedings of 48.3 million acres, if not lower.
Price Outlook
The overall wheat situation is bearish. Both the world and U.S. wheat balance sheets are far from tight. And, potential changes to the U.S. figures will most likely result in increased ending stocks. U.S. wheat exports probably will have a tough time meeting the USDA's current 1997/98 export projection of 1,075 million bushels. This development appears to be an ever-increasing possibility given the relatively ample wheat supplies in Australia, Canada and Argentina as well as the European Union's ability to subsidize wheat when it suits its own interests. Recent Export Sales reports continue to illustrate that the U.S. export program is off to a fair start at best, and the closer we get to southern hemisphere harvest, the dimmer the outlook becomes. We expect all of these factors to translate into greater carryout, which will weigh on prices longer-term.
Short-Term
The major swing factor for wheat revolves around the current dry conditions in the Chinese winter wheat belt (mainly Manchuria and northern portions of the North China Plains) and weather for the U.S. winter wheat crop. Of course, there is always the risk of poor weather for the southern hemisphere crops as harvest approaches, but Australian prospects for harvest probably are safer than for Argentina, where excessive rain cannot be ruled out due to the ongoing El Nino. Nonetheless, a drier pattern may emerge for Argentina by the end of November.
December wheat has the potential to test contract lows at $3.34¾ per bushel. Additionally, the market could have short-term risk below that level, but those moves could be muted if corn and beans start to show some support by year end, which we believe is possible.
Long-Term
Because most of the currently bearish fundamentals are longer term in nature, we do not expect to see the price environment change much into early spring. Despite the bearish picture that most fundamentals seem to paint, we do not recommend shorting the market at these levels with the hope of a rally in corn and/or beans spilling over into wheat. Likewise, we see no need to step in and take long coverage. But, if hedge policy dictates that coverage be established, then look to March call options for long protection. These options should be the cheapest on the board, and if prices do decline to levels where futures longs look attractive, then regard the loss in the call option as cheap insurance against a train wreck that didn't happen.
Longer-term swing factors include the winter weather's impact on the U.S. winter wheat crop (especially HRW in the Plains), 1998/99 U.S. wheat plantings (the first clue for winter wheat will be on January 10, while all wheat intentions will be covered on the March 31 Plantings Intentions report) and the eventual size of the U.S. export program.
November 26, 1997
Prudential Securities, Inc.
One New York Plaza, New York, New York
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