Category: Business

Key Points

The market has been assisted in recent weeks by the high levels of uncertainty. This week the wheat price has fallen, albeit remains strong.

Let’s start this weeks’ commentary on a global level. The price of a December CBOT wheat contract has fallen dramatically in the past week. On the 25^th March the contract was trading at A$352, it has now fallen to A$334. A fall of A$18 is considerable, however it has to be noted that it had risen A$51 during the preceding ten trading days (figure 1).

In Australian dollar terms the futures have lost some ground as our dollar increased from 55¢ to 60-62¢. A higher dollar reduces the price on an Australian denominated swap.

Fundamentally the wheat market is relatively bearish, however, the uncertainty caused by COVID-19 and the associated government interventions can add a huge amount of volatility. Here are a few reasons for movements lower in wheat:

• There are deepening concerns related to the global economy. As unemployment rates around the developed world skyrocket there will be a slowdown.
• Eqypt, traditionally the worlds’ largest wheat importer started a tender process then suddenly pulled the tender.
• There has been speculation that Russia will introduce an export ban. At present this is proposed as a 7mmt export limit between April and June. In reality no more than 7mmt would likely be exported in this time frame.
• Corn prices continue to edge lower as ethanol drops to record low levels in the US.
• The FAO expect near record wheat production in 2020.

In reality, the market has bearish tones, and if it were not for COVID-19 the pricing levels would likely be substantially lower than they are at present.

Key Points

Kansas typically trades at a premium to Chicago. However, since 2018 Chicago has been running at a strong premium. In September we put forward a strategy for a spread trade to benefit from a mean reversal in values.

The two wheat contracts in the US are the Chicago soft red winter (SRW) wheat contract and the Kansas hard red winter (HRW) wheat contract. These are two distinct contracts with differing specifications, the SRW is low protein (9.5%) whereas the HRW is mid protein (11%).

Typically, Kansas would trade at a premium to Chicago wheat. However, the spread has changed to a strong Chicago premium over Kansas during 2018. During September the spreads reached highs of 28% over Kansas, and an average for the month of 22%. The market has since fallen to 15% (figure 1).

Those who followed this spread trade strategy have a return of 13%, not a bad return on investment in the current climate. However, the spread remains at 15% – still well above the long term average of -3%.

As China starts to ramp up purchases as part of their Phase 1 obligations and extra demand for milling wheat due to panic buying – there is still an opportunity for this spread to return to normal levels.

So as a refresher, here are some strategies on how to do this:

What simple trades can we do?

Long Kansas: It is possible to take out a straight futures contract for Kansas. In this scenario, we would purchase the Kansas futures contract for a forward period. In this scenario, we would be buying with the expectation of Kansas futures rising to meet Chicago.

There is however a risk that the Chicago contract could fall to meet Kansas, or worse that Kansas falls further.

Spread trade: If we only want exposure to the spread between the two contracts, we can trade both Chicago and Kanas.

Whilst buying Kansas, we would take an opposing contract by selling Chicago. If this trade was executed, there would be no interest in the underlying price, only the spread between the two contracts.

Here are few hypothetical scenarios of the end results (table 1):

1. The spread increases: The trade will result in a loss.
2. The spread returns to normal levels: The trade will result in a profit.
3. The Spread remains the same: The trade will be neutral.

Remember to listen to the  Commodity Conversation podcast by Mecardo

What does it mean/next week?:

This provides an opportunity to participate in further potential falls in the spread between Kansas and Chicago.

As with all strategies, there are risks involved. It is worthwhile getting advice from your risk management consultant.

Key Points

Last week the Australian dollar was the major discussion point. The dollar floated like a lead balloon to lows of 55¢, the lowest level since 2001. This meant that our local pricing and Swaps increased dramatically. As much as last weeks fall was impressive, this week the rise has been equally dramatic.

At the time of writing this, the Australian dollar has increased to 60¢ (figure 1). During any other period, this would be considered an unusually strong move, but in the current environment large swings are to be expected.

In the previous weeks, wheat futures had actually been declining but the A$ was providing most of the benefit to local pricing. In this past week however, we have seen futures start to rise, which has somewhat outweighed the rising A$ (figure 2).

The reason for the rally was two fold. The panic buying seen around the world for staples such as pasta has resulted in an increase in demand from flour mills. This can be seen in the market preference for nearby contracts as opposed to further down the horizon. This has led to the forward curve moving from contango to a flat/backward structure.

The other major reason was anxiety related to the supply chain. There is a concern that a major exporter such as Russia or France, would be impacted by lock downs in the coming weeks.

At present agricultural supply chains remain essential around the world. In addition, Russia is unlikely to want to limit the income received through wheat exports at a time when crude oil receipts have fallen.

Mulling over the risk of a disruption to supply chains, I was thinking about recent times when this was a major concern. We haven’t had any human pandemics (except HIV) in recent decades, but an analogous situation could be the annexation of the Crimea in 2014.

There were concerns that this short conflict between Ukraine and Russia would result in export difficulties, the reality was that the grain still flowed. The question will be whether the market will continue to price in the risk of supply chain disruption.

Fundamentally the world is forecast to produce a large crop during the coming year, albeit with the share of production held by exporters declining. This year is however likely to be one of extreme uncertainty, and a good grain marketing strategy is important.

Remember to listen to the  Commodity Conversation podcast by Mecardo

What does it mean/next week?:

I don’t know what will happen in the next week, but I’d put money down that it will be volatile! At a local level grain prices remain strong.

Key points

• An annual average National Heavy Steer price of 335¢/kg lwt during 2020 would suggest forecast National Feeder Steer price of around 385¢/kg lwt, provided grain prices continue to soften toward the 2020/21 harvest.

• A forecast of 345¢/kg lwt for Heavy Steers in 2021 places the National Feeder Steer forecast nearer to 400¢/kg lwt.

• The difficulty in forecasting for the 2021 season is the long-term impact of Covid-19 on global beef, global grain prices and the A$.

Article

In a Meat and Livestock Australia (MLA) funded webinar that Mecardo delivered for Holmes and Sackett on restockers last week we were asked a great question on what our national heavy steer forecast means for feeder steer prices for the 2020/21 season. This piece looks at the relationship between heavy steer, feeder steer and feed grain prices and what it can tell us about feeder steer forecast levels for the next few years.

To access a copy of the MLA restocker webinar recording click here.

The Mecardo National Heavy Steer (NHS) forecast model is used to predict the annual average price of heavy steers in Australia using predictive inputs to the model such as the A$ level, global beef prices and domestic supply considerations.

The current forecast for 2020 is an annual average of 625¢/kg cwt (approx. 335¢/kg lwt), which is based on an A$ annual average of 67US¢ and an annual average US Live Cattle futures price of 110US¢/lb (Figure 1). At the moment both of these inputs are much lower on the back of Covid-19 speculative selling, with the Aussie dollar under 60US¢ and US Live Cattle below 100US¢/lb.

A comparison of the annual price change for National Heavy Steer and National Feeder Steer shows that there is a very strong correlation between the two (with an r2 of 0.8619) (Figure 2). This demonstrates that we can safely use the Nation Heavy Steer forecast model output to get an idea of the likely price forecast for National Feeder Steers, once we allow for how climatic factors and feed cost influence the historic spread between heavy steer prices and feeder steer prices.

Analysis of the percentage spread of heavy steer to feeder steer compared to the ASW price (smoothed over a 12-month average) highlights that during periods where there is a low feed price environment, the heavy steer moves to a discount of approximately 15% to the feeder steer (Figure 3). 

The big unknown at the moment is the long-term impact of Covid-19 on global beef, global grain prices and the A$. Local grain prices rallied last week despite softer international grain prices due to the collapse in the A$ under 60US¢.

What does it mean?

Assuming an annual average National Heavy Steer price of 335¢/kg lwt during 2020 would suggest an annual average National Feeder Steer price of around 385¢/kg lwt, provided grain prices continue to soften toward the 2020/21 harvest.

For 2021, the Mecardo National Heavy Steer model forecasts an annual average price of 640¢/kg cwt (345¢/kg lwt) but this is based on an A$ of US70¢ and US Live Cattle at 115US¢/lb. If the Covid-19 impact is short-lived and the A$/US Live Cattle futures can rebound from their current levels, there isn’t any reason why we can’t achieve these forecast levels for the heavy steer. 

Furthermore, based on an assumption of cheaper domestic feed prices and a 15% discount of heavy steer to feeder steers into the 2021 season the feeder steer forecast would be nearer to 400¢/kg lwt.

Key Points

The markets have gone truly bananas. In a good way for growers but not necessarily for consumers. In the past week, Chicago wheat futures have risen to the highest level since 2012 (in A$ terms). This provides a great opportunity for farmers to start their 2021 marketing at extremely strong levels. 
Let’s start where the real excitement is. The A$. Australian agriculture for the most part of export orientated; this means that with a lower dollar the local price can rise dramatically due to buying in Australia from overseas effectively being cheaper. 

The A$ has been feeling the effects of gravity since the start of the COVID19 crisis. At the start of the year, the expectations from most banks was an A$ in the low to mid 70’s. The mother of all black swan events has caused all forecasts to be wildly wrong. In figure 1, we can see the Australian dollar against the greenback, and it has hit levels not seen since 2002.

So what about grain? In figure 2, Chicago wheat futures for December are displayed in both US$/mt & A$/mt. The market has rallied substantially in both however the rally in Australia dollar terms has been more pronounced.

This is an opportunity for producers. At present, it is possible to book in a wheat swap for the coming harvest at A$347/mt. This is an extremely attractive number historically and places it at the highest level since 2012. 

We advise that all producers enquire with their banks about the option for using swaps for mitigating risk. It is important to get this facility set up, it doesn’t cost anything. It’s better to have it and not need it than need it and not have it. 

Remember to listen to the  Commodity Conversation podcast by Mecardo

What does it mean/next week?:

The market is crazy with a huge amount of volatility. What is going to happen next week? No-one has a clue. We are in uncharted territory, the US dollar is considered a safe haven which has caused a decline in our currency. 

We might find the US response lacking and see an exodus from the greenback. It’s all speculation at the moment, but in reality agriculture seems quite resilient to these times.