Category: Grain

An exciting week in markets, with volatility across equities and currency. In the past week wheat futures have performed well, but has the benefit been passed onto local growers? Overnight the WASDE was released, and it provides some data that is good for Australian grain in the long term.

The WASDE report was released overnight. The report was largely bereft of much in the way of surprises, with tinkering around the edges. The summary of the report is provided in table 1. On a month on month basis, the end stocks for wheat, corn and oilseeds were all reduced. This has to be tempered by the fact that season on season, end stocks are still strongly up, with the exception of corn.

An interesting piece of data in the report, was the imports of wheat. Egypt has traditionally been the largest importer of wheat; this year Indonesia is expected to take the crown. As we can see in figure 1, there has been a rapid increase in imports in the past five years. Increased Indonesian imports are of benefit to Australian farmers, as we have a geographic advantage into this destination. The question remains on whether imports have been higher due to low pricing, or whether this will continue to be a long-term trend when prices rise.

The futures market overnight took a tumble (figure 2), nonetheless futures when converted into A$ remain $15 higher than the same time last week. At a local level the full benefit of the futures rally has not been passed onto local growers, with basis levels (figure 3) falling between $5 and $11 dependent upon zone.

One thing to keep in mind is that although basis levels have fallen since harvest, they have fallen from close to record levels. In our articles prior to harvest, we recommended selling basis, as it was very top heavy.

I recommend re-reading the article ‘3 elements that need to be considered when selling grain’, this will gives some indication on how we can improve our risk management strategies.

 

What does it mean/next week?:

The A$ is currently falling, which if it continues this trend will add additional value to export pricing, and make it more attractive to buy in Australia.

The key focus will be on the US weather, with drought seemingly spreading further their productive potential will be constrained, if no rain is received in the next six weeks.

 

Time flows like water down the river rapids, we are now into February and the holiday season is now but a distant memory. January has come to an end, and it’s worth examining how the start of the year has gone.

The futures market has risen sharply in the past three weeks (figure 1), this has been as a result of a depreciating US dollar (discussed here) and weather concerns. The market is concerned about weather patterns in the US (see map), which show abnormally dry conditions across much of the country. Although still early in the season, the speculative short in the market as at close to record levels, which can lead to sudden swings in the market. Time will tell whether the weather risks, are enough to warrant a sustained rally or whether the large global stocks are enough to constrain pricing.

The A$ has been like a steamroller since the beginning of December (figure 2), with 81¢ being achieved last week. Whilst there has been

a modest fall, it has remained stubbornly above 80¢. The RBA have their first meeting of the year next week, and it is expected by most that rate will remain at current levels (1.5%). However, currency analysts are having divergent views on when rates will rise, with the following forecasts:

• ANZ forecast two rises in 2018, with the first possible in Q2
• Credit Suisse believe that there is the potential for a rate cut in 2018
• UBS forecast no rate hike in 2018
• Morgan Stanley forecast no rate hike in 2018, but a rise in 2019

I was asked this week why local prices have not moved in line with futures. The futures prices have rallied, at the same time as the A$. This takes some shine off when converting to a local value. However, the basis level has slid downwards since harvest. It has to be remembered that basis levels are still very strong, and technically we are actually receiving very strong prices compared to the rest of the world.

In recent months, we have discussed the reality of high basis prices and provided some advice on ways to lock in basis through a physical sale, and keeping exposure to the futures market. Those who followed this advice, have now benefitted from locking in a historically strong premium, and can now also benefit from futures rises.

I recommend reading the following article on, which briefly explains a number of strategies:

How to defer grain pricing

What does it mean/next week?:

As always at this time of year the market will be looking towards the weather, what does it have in store for the northern hemisphere crop. It is currently a balancing act between potential depleted production in 18/19 against record global stocks.

The RBA interest rate announcement will be made, it is likely to remain the unchanged and remain at record low levels.

 

The week has overall ended up positive for grain producers in Australia. The market has been largely driven by noises from the white house, which seem to have very opposing views on the future of their economy. In this weeks comment, we take a look at the descent of the Chicago futures, and the strong ascent of the Australian dollar.

The futures market has regained some traction in the past week, with Chicago spot futures up 4% since the 19^th Jan. There are some concerns about weather in the northern hemisphere, but the increase in futures has largely come from weakness in the US Dollar. In figure 1, the spot Chicago futures are shown in both US¢/bu and A$/mt.

The fall in the US$, and the subsequent rise in A$ has led to the increase in A$ wheat swaps being weaker, albeit still reasonable at 3% week on week.

The US$, has been weakening in the past fortnight due to mixed signals from the US administration. The US secretary of state, had made comments pointing towards a weaker US$ being positive for the economy. This sentiment points to the likelihood of limited interest rate rises in the coming year. However, President Trump provided a conflicting view that the dollar will be stronger, and that was the aim of the government.

In figure 2, the US dollar index (DXY) is plotted. The DXY is an index based on a trade weighted basked of currencies against the US$. In recent weeks, the greenback has declined to it’s lowest point since December 2014.

This weakness has flowed through to the A$, which has gained ground to close above 81¢ (figure 3). The improving value of the A$, contributes to making local export commodities less competitive on the world stage, however in theory imports should be cheaper.

The current rise in the A$ is largely as a result of US weakness, and with the unknowns of the political machinations of the white house, we could be in for a rocky period of time. If the market regains confidence in President Trump’s claims of a stronger dollar, we could see a decline in the A$.

What does it mean/next week?:
The market continues to look towards the northern hemisphere. We are currently experiencing La Nina conditions which can lead to a drier than normal conditions in the US, this is starting to be seen.

We are still a long way from the finish line when it comes to the US crop, but signs are point towards relatively poor conditions, and with low planting figures any issue can be exacerbated.

The markets have been very quiet over the past week, with little in the way of new information to get the trade excited. Usually in our Friday comments, we would take a look at the past week. This week, I thought I would take a quick review of the past two years.

In figure 1, the Chicago spot wheat futures, converted to A$ has been plotted. The past two years has not been pretty, the average price in this period has been a meagre A$211/mt. The futures price makes up the bulk of our price in Australia, we have a very low floor with which our local premiums can contribute to.

The basis is our premium or discount between the physical and futures market, and typically we compare Australian prices to Chicago futures, but it can be against any other pricing point. Basis is important as it can help substantially to increase the prices that we receive locally.

In figure 2, we can see the basis between APW1 and Chicago futures. As we can see, for the bulk of the past two years levels have been at a premium, with a short period of time where SA has experienced negative levels.

This season we can see that basis levels have been extremely strong since seeding. This is due to the weather risk, and then the realization that the Australian crop was going to end up below average. This basis has helped push up localphysical prices to provide a much stronger return for growers.

What is important to remember is that basis levels are largely driven by supply (or lack of), and if Australia had produced an ample harvest, then our basis levels would have been much lower, in combination with a period of low futures prices.

You would have to be living under a rock, if you hadn’t heard about the stratospheric rise of bitcoin. Although of little analytical benefit, I thought this was quite interesting to look over time at how many tonnes of wheat that you can buy for 1 bitcoin. This is displayed in figure 3, in mid-December a bitcoin could get you 122mt on the Chicago futures market, today it will get you 73mt.

What does it mean/next week?:

The market is likely to be quite dull in the coming weeks. There now seems to be less concern about the northern hemisphere crop, and every week that flows without an issue removes risk.

It sounds bad, but we need a supply issue to our fellow farmers in the north. We can’t rely too heavily on basis to make us profitable.

At this time of year, those lucky to have grain on hand will now be deciding whether it is best to sell their grain or hold on for higher prices. There are many ways of deferring pricing, and give exposure to the market at a later date. This short article will provide summaries of easily accessible options.

Storing to sell

Exposure: Basis & Futures

The obvious option for deferring pricing is to hold onto your grain and sell at a later date. This can be carried out either through central storage or through your own on-farm storage system.

Key considerations:

• Remember to calculate your storage costs and interest charges if storing in the system, this amount has to be recouped to make it worthwhile.
• Place a realistic price on your time, capital, fumigation and interest when storing on farm.
• Whether your on-farm storage is in a good enough condition to make it to the targeted sales timeframe.

No Price Established contract (NPE)

Exposure: Basis & Futures

 The NPE contract comes under a number of different product names through different providers, however all perform the same function. The purpose of the contract is to provide traders access to grain, when the grower doesn’t like the price. The grower is then given a predetermined timeframe in which to secure their price.

Key considerations:

• Check what the product fee is.
• Is there an advance?
• Check how the pricing is established. What is the methodology if the trader is lower than the market?
• Do not use an NPE if the contract is only based on the trader’s price.
• Maintain a close eye, and remember that it is a time-based contract.
• Check whether storage and handling fees still apply.

More in depth information:
http://blog.mecardo.com.au/grain-canola-npe-contracts-the-simple-facts

Cash and Call

Exposure: Futures

The cash and call strategy involves the use of derivatives, but is not particularly complicated (guide on link below), and can be transacted through most banks or through a broker. The cash and call strategy is suitable when basis levels are strong, and futures are low. At its simplest, the grower sells his physical grain and then takes out a call option, which provides a benefit if the futures market increases in value.

The call option works in a similar way to an insurance, where the grower has a known worst-case scenario, in exchange for paying a premium.

In the Cash and Call strategy, the grower has a known cost (Premium) and for this cost has exposure to future favourable price increases. If the market price of the Call Option does not increase, only the Premium is lost.

Key considerations:

• Is the market structure favouring removing basis exposure, whilst retaining futures potential?
• Does your bank have the capacity to offer these instruments?
• There are no further storage costs in this strategy.
• The market has to climb higher than the premium to provide a positive pay-off.
• The premium will change dependent upon time, and strike price.
• There are some pool providers offering managed products which are based solely on the cash and call strategy.

 

More details:
http://blog.mecardo.com.au/i-dont-like-the-grain-price-but-i-need-the-cash

 

Buying a swap/futures contract

Exposure: Futures

The traditional method of utilizing a swap, would be to sell a swap prior to harvest to lock in a futures price, and then unwind the swap by buying back the swap from the bank at or near harvest. Although not common practice amongst farmers, it is possible to buy a swap/future contract.

It is possible with many banks to turn it around and instead of selling a wheat swap, buy a wheat swap. Let’s say for instance the current basis levels were high, and futures were low. It would be possible to sell your physical grain and lock in the basis, at the same time as buying a wheat swap.

The buying of the swap would give an exposure to the futures market. Therefore, if the futures market rallied you would participate in any upside. In an ideal world you would then close out your swap position when you had reached your target price, and with the addition of the basis already captured, would be your overall price.

Key considerations:

• Is the market structure favouring removing basis exposure, whilst retaining futures potential?
• There are no further storage costs in this strategy.
• Some banks will not allow a grower to buy a swap, and those that do will likely want to see a physical sale contract. This is to ensure that the instrument is being used as a hedge and not for speculative activity.
• A direct futures contract with the exchange will be cheaper but has the potential for margin calls.
• Should the market fall further after the swap is taken this strategy has the possibility of loss, further eroding the final overall price.

More details:

http://www.mecardo.com.au/commodities/analysis/turn-grain-swaps-around.aspx

Pools

Exposure: Dependent on pool strategy

Prior to 2008, wheat pools were the primary marketing route for the Australian growers. This has changed dramatically and <30% would be expected to be marketed through managed programs. The breadth of providers and products has however ballooned to fight over the remaining pool participants.

At its most basic, the pool is a product where growers provide a manager with tonnage with the expectation that they will manage this to provide a better return than they could achieve themselves. Typically, an unpriced scheme or product would be considered a financial product and require an Australian Financial Services Licence (AFSL), however an exemption for grain pool has been extended by ASIC.

What to keep in mind when selecting a pool:

• Does the pool strategy meet your requirements and your own view of the market?
• Do you think the pool provider has the experience to operate the pool?
• Does the pool provider have an AFSL? This gives an indication that the provider must take compliance extremely seriously.
• What are the payment schemes, and how do they work with your taxation and cash flow requirements?
• Pool providers put together some flash marketing, ignore this.
• Check past history, but remember that past performance is not an indicator of future performance.

Dawn has broken on 2018. The start of a new year brings fresh possibilities, and a few positive signals have started to appear in the market. In the zodiac calendar 2018 is the year of the dog, let’s hope that its wrong and we are in the year of the wheat bull.

So far in 2018 the wheat futures market has shown some positive signs. In US¢/bu. Chicago futures (figure 1) have gained 3% since boxing day, although the A$ has removed most of the shine from the rise. The market is currently starting to price in weather risk into the US winter wheat crop, after a series of cold weather events is likely to have caused some damage since inadequate snow cover was in place.

These weather events come on the back of a USDA crop progress which is particularly bullish (figure 2). This chart shows the current percentage of the crop rated as good to excellent. As we can see, with the exception of Colorado, all states are showing substantial year on year reductions in the good to excellent category. It has to be taken into account that this rating was determined prior to the cold snap, and it is liable to be downgraded further.

At a local level, after relatively lacklustre grower selling throughout, harvest sales were more forthcoming between Christmas and New Year. This increased selling pace has led to a depreciation in basis levels (versus Chicago). In figure 3, we can see the extent of the fall in basis since just prior to Christmas, which was largely inevitable and was discussed in following articles:

Lock in premiums, keep exposure to the market

Wheat seasonality: Imitation is the sincerest form of flattery

Let’s look back at historical basis

It remains to be seen whether basis levels will improve as the festive season draws to a close. At present most businesses are still operating at relatively low levels, with many not returning until the 8^th January.

Next Week

The market will continue to examine weather risks due to cold and la nina in the northern hemisphere. I don’t expect big jumps in the coming week with the exception of potentially speculatively driving rallies.

It will be interesting to see the direction that basis takes this week; will grower selling pace result in further falls or will more buyers come to the table and drive it north?

We are just on the brink of silly season, where the majority of the western world will effectively stop. There will be skeleton staff in most organisations (including Mecardo), and there will likely be little new activity. In this week’s comment, we have a look to see if the market has provided any pre-break cheer and joy.

This week saw the end of trade in the December 2017 CBOT futures contract, and we thought it was worthwhile highlighting the performance of this contract. In figure 1, we can see the price from the start of trading in July 2015 to present. Apart from some northern hemisphere jumps mid-year in both 2016 & 2017 the market has been on a downward tradgetory.

In Australian dollars the December contract closed at $188, $90 below the peak achieved in July 2017. Growers who participated in a swap at this level, will be rewarded with a substantial return due to the swap profit and strong basis levels.

The Australian dollar regained strength this week (figure 2), on the back of stronger than expected jobs data. The Fed reserve also increased rates however have pointed to three rate rises in the coming year, a more gradual increase than expected.

The USDA released their December WASDE, which was as expected. The December report typically offers little in the way of surprises and is largely an adjustment exercise. In reality, if you want an update on the December WASDE, just read about the November one (click here).

The report pointed towards continued high stocks (figure 3), which unless something goes wrong in the northern hemisphere will lead to continued depressed pricing. The USDA interestingly maintained production in Australia at 21.5mmt, which will have to be adjusted in future reports.

So overall, this week there hasn’t been much data to provide joy this Christmas, but all it takes is an issue in the north to get improvements in price.

Next week

An interesting place to keep an eye on is Ukraine, which has very cold weather approaching but with little in the way of snow cover.