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Wednesday, March 11, 2015

Corn looking expensive, wheat cheap but there are reasons

By Angus Brown  |  Source: CME, ASX

Key points

  • The US wheat premium over corn has fallen to an 18-month low on the back of falling wheat and steady corn prices.
  • Wheat is historically cheap relative to corn, and should correct back to around average with ‘normal’ weather conditions for the US corn crop.
  • The opportunity for growers is to use corn to hedge cereal production, while consumers can be comfortable hedging on wheat.

2015-03-10 Taking Advantage Of The Wheat Corn Spread FIG 1

2015-03-10 Taking Advantage Of The Wheat Corn Spread FIG 2

Since the December spike in wheat prices, values have gradually declined to sit close to a four-and-a half-year low of 480¢/bu in US terms. While wheat has been forced lower, corn has remained relatively steady as the crop is yet to be sown and there is still plenty of production risk. Both producers and consumers can take advantage of the tighter than normal spread, but there are risks.

Figure 1 shows just how marked the difference in wheat and corn price movements have been since Christmas.  CME Wheat has lost 24% since the December peak. Adequate supply, the alleviation of concerns surrounding Russian and Ukrainian exports and the rising US dollar have all combined to see the market fall.

Corn, on the other hand, has remained relatively steady since Christmas. South American supply is largely as expected. The US crop still holds plenty of production risk with the crop yet to be sown, and weaker prices are expected to curtail plantings. 

Figure 2 shows what the recent price movements have done to the wheat/corn spread, with the wheat premium having fallen from 65% to 26% since the start of December.  In Australian dollar terms, the wheat premium over corn has fallen from $91 to $34 over this period.  Even during the US wheat harvest last year, the wheat premium only got down to $40/t, or 29%.

If all goes to plan with US corn plantings and crop development, it is likely the wheat premium will return to around the average of the last two years of 43%, either through the corn price falling or the wheat price rising.  This will be driven by the relative feed values and grower margins of the two grains, which will see more wheat consumed or less planted, and vice versa for corn.

There has been, in the recent past times, two years when the wheat premium to corn ranged between 0 and 15% as US corn production fell and world wheat production was adequate. World wheat production is spread between a number of major producers, while corn is concentrated in the US and South America, which leaves corn more highly exposed to US drought.

What does this mean?

Essentially, the narrowing spread between wheat and corn means that there is a strong probability that the wheat premium will widen, either through rising wheat prices, falling corn prices, or both.  The opportunity for growers is to sell corn futures or swaps at the current new season rate for around A$213/t, with the expectation that the wheat premium will return to average.  If that happens through corn falling, it will lose around $25/t, or wheat will rise $25 to $270/t. Either way, it should result in better net wheat prices if corn swaps are sold.

The risk in this strategy is issues with the US corn crop, which could see corn prices rise relative to wheat. In this case, sold swaps will incur a loss without an equivalent rise in the wheat price to compensate the grower.  For consumers, the current spread is simply another indication that wheat downside is relatively limited, and reasonable buying.

Mecardo information is provided to assist in your marketing decisions. It contains a range of data and views on the current market. It is not intended to constitute advice for a specific purpose. Before taking any action in relation to information contained within this report, you should seek advice from a qualified professional. The information is obtained from a variety of sources and neither Mecardo nor Ag Concepts Advisory will be held liable for any loss or damage whatsoever that may arise from the use of information or for any error or mis-statement contained in this report. 


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