Everyone wants to know what prices are going to do, myself included. As a market analyst, that is the No. 1 theme of every question asked. Where are grain prices going from here? Where do you think they will be this fall? What about the dollar, can it go much higher?
Of course, I put a lot of time and effort into trying to answer those questions, especially for grains. Here at DTN, we have the Six Factor Market Strategies which combines different facets of fundamental and technical analysis to help us understand where prices are headed, but no matter how much analysis is performed, there is always a component of uncertainty that cannot be ignored.
I don’t say this to discourage anyone from studying the markets. There is value in staying informed and those that do their homework are also the first ones to recognize when something new or unexpected is happening. However, instead of just asking where prices are headed, most investors and producers would be better served by focusing on grains’ value.
As an example, consider the current market for Chicago wheat. Dec. Chicago wheat closed Monday at $5.29 1/2 which is near its lowest price in five years (one of DTN’s Six Factors). A little bit of homework shows that Monday’s price was also 7% below USDA’s estimated cost of production for wheat for those that own their land outright or 27% below the cost of production for those that rent ground.
It is not uncommon for Dec. wheat to trade below its landless cost of production as it has happened in 17 of the past 30 years. And just because wheat prices are trading below cost does not mean that they can’t trade lower in the short-run. In 1998, during Asia’s financial crisis, Dec. Chicago wheat fell to $2.51 a bushel which was 28% below cost.
From a long-term perspective, it is easy to see that wheat prices below their cost of production are not sustainable and represent good value for patient investors. Like any agricultural product, wheat doesn’t plant itself and jump in the bin. The world cannot have a steady supply of food without rewarding producers and adverse weather is a constant threat to production.
In June 2010, Dec. wheat prices were also near $5.00 a bushel, much like they are today, but U.S. ending wheat stocks in 2009-10 were at 48% of annual use, 10 points more than USDA’s estimate of 38% for 2015-16. The economic climate for grains was more bullish in 2010 than it is today because corn was in the process of expanding acres for ethanol and the U.S. dollar index was 12% lower than its current price.
But it is also true that today’s economy is much bigger. U.S. GDP totaled $14.89 trillion in the second quarter of 2010 and is now at $17.84 trillion, a gain of nearly 20%. The U.S. Labor Department’s index of consumer prices is up 9.5% since June 2010 while wheat prices are roughly unchanged.
Unlike the expansion we have seen in corn and soybean acres, U.S. wheat plantings have barely budged since 1973. In fact, USDA says that the whole world’s harvested area of wheat is only up 3% since 1973. At these low prices, there is no worry of significantly more wheat acres anytime soon.
Back in the world of short-term expectations, the fundamental outlook for wheat is currently bearish as USDA’s estimate of world ending stocks totals 31% of annual use and the high U.S. dollar is making export sales difficult. At this point, it is difficult to see what could propel wheat prices higher, but CFTC data does show commercials net long 15,193 contracts in Chicago wheat as of Aug. 4, a bullish sign from the firms that know demand best.
In October 2008, Warren Buffett took to the pages of the New York Times to tell us why he believed equities were offering good value. He explained, “I emphasize that I have no idea what the market will do in the short term,” but clung the knowledge that “bad news is an investor’s best friend.”If we can get past the confusion of short-term expectations, it’s easy to see a similar case for long-term value in wheat.