Wheat Futures and Basis De-couple: Will Soybeans and Corn Be Next?

Corn SoybeansIt has become popular over the last few weeks to compare the wheat market with Newton’s laws of physics.  The analogy is an obvious one because I believe it was Sir Isaac Newton who threw an apple up in the air, which turned around and hit him on the head, thus leading to the discovery of gravity.  So in other words what goes up, must come down, waiting for wheat to do that is just a matter of time.

The wheat market has certainly had its fun.  My question is whether the same thing will happen for corn or soybeans looking ahead.  It will happen of course, but nobody knows in what year that will be.  It was only five short weeks ago that Ontario wheat prices were in the doldrums.  Now, you cannot even contract wheat for 2011, as elevators are not willing to hedge that risk.

Next week at this time we will be considering the USDA numbers on crop production and the world supply and demand estimates which will be released a week from today.  I’m wondering if there will be any surprises in those reports, it seems everybody is saying that yields will be boosted next Thursday.  If that is the case, one might think that we will be heading into more bearish territory unless the wheat market is still going crazy.

For Ontario producers the run up in grain prices has been tempered by the loonie finding a little bit more testosterone.  It has moved back into the $.98 level, which always has a dampening impact on Canadian cash prices.  Ontario basis levels for corn have moved down, partly because of the loonie, but more because Ontario end-users can see a record crop in the field.  There is no incentive to stimulate basis under that scenario with ample amounts of grain seemingly almost everywhere.

Which I must surmise is a very strange situation.  Or is it a case where Eastern Canadian producers as well as our friends in the American Corn Belt are simply benefiting from somebody else’s trouble?  For instance the drought in Russia is said to be a once in 130-year event and we know that we have the least seeded acreage in Western Canada in 39 years.  So this year it looks like higher prices will come on the backs of Russian and Western Canadian producers.  Meanwhile in Eastern Canadian farm country there is a huge surplus of wheat and bountiful crops of corn and soybeans in the offing.  It would seem to me that “distribution” of these global crop shortfalls surpluses this year have everything to do with why prices have risen so greatly.

The implications from the production problems will become apparent over time.  It should also be pointed out that although nobody knows what the price of wheat will do, quoting the current price as the highest in the last 22 months is a bit of a tale.  The current price for wheat at Chicago is the second highest price event in history compared with the run-up in 2007.  This price movement will surely impact feed grains around the world and with three weeks left in August, there is still quite a bit of time for the situation to evolve.

I just don’t see corn and soybeans acting like wheat in 2010.  However, consider the source when I say that.  My reasoning is that wheat is grown everywhere and the problems in Canada and Russia have tipped over the turnip wagon.  In corn and soybeans their production is more concentrated.  So it would take a production calamity in North America to affect corn prices adversely, the same for soybeans except for the South American dynamic.  The situation remains very fluid and producers need to tread carefully.  The last five weeks of market action should serve as an example of how volatile agricultural prices can be.

It should also be said that there are limits on Canadian cash prices for grain in such a volatile futures market.  I have been asked the question several times lately about the divergent futures and basis values for corn and wheat in Ontario.  It seems many producers think basis should march in a certain pattern with futures prices and when it doesn’t happen, they cry foul.  However, in fact basis levels in such volatile market conditions like the wheat market simply reflect the end-users appetite to buy. When futures prices go into the stratosphere, end-users with grain coming out of their ears, ratchet down basis.  In wheat it’s happening on a daily interval and if corn gets really high it will happen to that commodity too.  The eastern Canadian marketplace is not vertically integrated enough to change that pricing paradigm.

So keep an eye on those USDA reports August 12th.  It may be a new day or it might be a day we’ve seen many times before.  If it gives you any solace, “index funds” currently own on paper, 367% of this year’s US soft wheat crop production according to the American Bakers Association.  Simply put, it means big volatility ahead.  Of course its never as much fun when it goes down versus going up.  Remember, Newton’s laws.