November 24, 1997 ..Issue 16
If supply is greater than demand, surpluses will build, and prices are most likely to drop
I recently went out on the Web and opened the weekly USDA - AMS Pacific Northwest Market Summary, for Thursday November 13 and found this. "December wheat futures ended the reporting week on Thursday, November 13, substantially lower as follows compared to last Thursday's closes: Chicago 16-1/2 cents lower at 3.41-1/2, Kansas City 11 cents lower at 3.56-1/2, Minneapolis hard red spring wheat 8-1/4 cents lower at 3.79-1/2, and Minneapolis white wheat 17 cents lower at 3.89." (By Nov. 20, Minneapolis Dec. contracts had dropped further to $3.75)
. . . you didn't have to be on the Web
to know prices have come crashing down.
The weekly PNW report gave one part of the explanation as to why the plummet in wheat futures prices. "Wheat futures were pressured early in the week by sharply lower corn futures following the release of the USDA's Crop Production and Supply and Demand reports on Monday, which were considered to be bearish to corn futures". So the wheat market has been propped up by the corn market - nothing especially new there. Wheat is a substitute for corn in feed markets when corn prices get out of line with wheat prices. But there is more - some of "the rest of the story" - that I believe is found in the underlying supply and demand situation for wheat. As you know, one of my favorite pastimes is to keep pointing at this very basic foundation of market fundamentals, supply and demand. (My economist mentors at WSU would be proud of my understanding of economic theory - they weren't so sure when I was studying there!!!)
USDA and most private forecasters predict supply, demand, and ending stocks, using June 1 as a beginning and the following May 31 as reference points. USDA revises their forecasts each month during the marketing year as more information is learned about US and World market and growing conditions. USDA and many private forecasters recently raised their world wheat production forecasts for this marketing year, which runs from June 1997 through May 1998. This year's crop will be the largest wheat crop since the record crop of 90/91.
Demand for wheat was also forecast to be up this year. So if use is up, what will the final impact be? Ending stocks are one indicator where supply and demand are moving in relationship to each other. Every forecast I've seen this marketing year has predicted ending stocks will be up significantly this year over last. I don't know about you, but to me that means downward pressure on prices. There will be other forces that may counter that downward pressure. Earlier in the year, it was forecast that Canada and Australia's crop would be down from a year ago, opening trade opportunities for US grain and therefore providing some upward pressure on prices. But both Canada and Australia's crops are going to be better than forecast earlier, although still down from last year; and all of the trade opportunities predicted for US grain have not materialized. Russia, to about everyone's surprise, has become an exporter of wheat this year. A single year aberration? We won't know till next year.
But back to basic supply and demand - after proofing this newsletter, Marge tells me I need to add a few definitions:
Supply = beginning stocks plus imports plus production.
World ending stocks are forecast to be 128.54 million metric tons (mmt), up from 105.40 mmt. just two years ago. To place this number in perspective, world production is predicted to be 603.04 mmt this year and US production will be about 68.76 mmt. But rather than focus on the absolute ending stocks number, a more useful indicator of supply and demand is the "stocks-to-use percentage" which is calculated by dividing ending stocks by total use for the year. This percentage represents the percentage that the surplus from this year is of total use.
The stocks-to-use percentage is an indicator of relative size of the carry over from one year to the next. There is agreement that there needs to be some level of reserve from one year to the next to cover a potential shortage in production caused by weather or other events. There is no agreed upon level though of the reserves that the "market" feels are needed so that shortages do not occur if production drops dramatically from one year to the next. There does appear to be a reserve level below which buyers begin to get nervous. The safe level of reserves from one year to the next for the world wheat market is a moving target. It used to be (1960's) that "the market" thought a 30 percent reserve was necessary, so a stocks-to-use percentage below 30 caused some panic in the market. The "fear of shortage" level seemed to have dropped to near twenty, but last year prices continued to drop even though the stocks-to-use percentage stayed below 19.
Market analysts identify this trend by saying that the "market" is getting comfortable with or is adjusting to lower stocks-to-use percentages. There are a number of reasons for this comfort level, which will make another issue of this rag. This changing perception is one reason to be very cautious when you read that stocks are at historic lows. Stocks may be at historic lows, and some would say you could still define world stock levels today with that language. But a more important issue is how will the market respond to those stocks levels. It appears buyer's nerves have hardened and what "historic low" meant yesterday doesn't automatically mean "higher prices" today.
The US stocks-to-use percentage is expected to climb even faster than the world percentage this year.
So having said all that, here is where ending
stocks are headed this year. The world wheat stocks-to-use percentage
is expected to climb to 22.0 from 18.8 last year. The US stocks-to-use
percentage is expected to climb even faster than the world percentage
this year. The US stocks-to-use percentage will rise to 27.2 this year,
up from 19.3 last year and 15.3 in 95/96. To put this in historical perspective,
this year's US ending stocks for all wheat will be the highest since the
disastrous 90/91 market year when the stocks-to-use percentage was 35.7.
This year's stocks-to-use percentage will also be 4 percentage points
higher than any year since 90/91. Remember as you try to calculate how
the market will interpret this - the market seems to be "more comfortable"
with lower ending stocks levels. Put yourself in the shoes of wheat buyers.
Do you think major wheat buyers believe this might mean that there is
little chance of rising prices and possible shortages? "Just-in-time"
purchases at these stocks levels carry little risk of shortfalls (ignoring
of course the Union Pacific Railroad mess!). Buyers can wait for lower
prices to fill their wheat needs.
White wheat ending stocks are forecast to be up 8 million bushels to the highest white wheat stocks level in 4 years. The 67 million bushels predicted to be around by May 31,1998, is up 12 million bushels from May, 1996. Will you be one of those holding those stocks when the new crop begins to hit the market? Uncle Sam won't! The 96 Farm Bill forbids USDA/CCC to hold stocks above the strategic reserve levels. Not only will the US government not be purchasing surplus wheat, several other governments around the world have adopted the same policy, meaning the affect of supply and demand is more likely to play itself out in the market.
In 1990, the US (both public and private) held 22 percent of world wheat stocks. Prior to the late 1970's the US averaged about 33 percent of world stocks. Last year we held about 10 percent of the world's stocks and that will rise this year to about 13.4 percent of the world's ending stocks. The big difference today is that almost all unsold wheat will remain in farmer's hands. In the old days, Uncle ending up owning lots of wheat when prices dived - ain't so now - by law!
Earlier this year I reported that grain market analysts believed grain prices would follow a more normal pattern this marketing year than last. Looking at world supply and demand estimates, I'm not so sure. Looking ahead at Australia and Argentina wheat entering the market in the months ahead, even if at lower levels than last year, I'm not so sure last year's pattern may not be closer to what may happen. But don't take my word - use your own intuition and knowledge and look at what other analysts are saying.
Futures markets, with all their problems, are one means of price discovery into the future. At the top of this story I reported on recent precipitous drops in futures prices, which seems to be continuing. Futures contract prices are one indicator of where certain market players feel the market is headed at a current point in time. Providing additional insight into where the market may head is the spread between December and March contracts and March and May contracts. The spread in Minneapolis white wheat futures contracts reported on November 19 was 8 cents between December and March contracts and 8 cents between March and May contracts for a total of 16 cents for the next six months, an average increase of 2.6 cents per month. The Kansas City December and March futures spread is about 8 cents and closing (it became smaller by 4 cents from Nov 18 to Nov. 19) and the March - May spread is 8 cents. Chicago contracts had similar spreads.
Here are some questions for you to think
about as you ponder your marketing plan.
I've discovered a good Web Site with some great world ag trade and ag weather information!
The USDA Foreign Agricultural Service Current World Market and Trade Reports, at http://www.fas.usda.gov/currwmt.html.
The reports found at this site are drawn from the weekly reports by the US Foreign Agricultural Service personnel located around the world. Much of World supply and demand estimates developed in the US are built from these sources.
You may wish to try these other ag related Web Sites.
Desktop publishing and distribution by marge Schoessler,
§ Ph: 509 659-3211 § Fax: 509 659-3206 § e-mail: firstname.lastname@example.org
Member, WSU Cooperative Extension Ag Horizons Team
Styer - CRU