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Wednesday, February 19, 2014

Should you be hedging new season wheat?

By Angus Brown  |  Source: CME, ASX

Key points

  • Current swap values are largely uninspiring, but remain reasonable value relative to historic prices.
  • ASX and local forward prices are priced better on a historical basis, as forward basis is currently strong.
  • Wheat prices usually increase in volatility in autumn, but if targets are not hit by April some cover on swaps should be considered.

2014-02-17 Should You Be Hedging Wheat FIG 1

2014-02-17 Should You Be Hedging Wheat FIG 2

2014-02-17 Should You Be Hedging Wheat FIG 3

With most 2013-14 grain sold, attention starts to turn towards new season pricing with the usual hedging window now open. The only problem is uninspiring prices for new season grain. So what are the options for hedging, and is it worth it?

December 14 Chicago Board of Trade wheat swaps in Aussie dollar terms are currently trading at A$262/t, which, as shown in figure 1 (red line) is at around the average level of the last 12 months of the rolling spot contract.  The current swap price is around $80 higher than the lowest price we have seen in the last 5 years, and also $70 below the highest price.  

In percentile terms, figure 3 shows the CBOT Dec-14 wheat swap in our terms is at the 57th percentile, while the spot price of $249 (not shown in table) is just above the 40th percentile over the past 5 years.

However, if we look at historical December prices (figure 2), when harvest ramps up and swaps expire, the current price of $262/t is only significantly lower than 3 out of the past 12 years, while being similar to 3 years and higher than 6 years, which makes it look like reasonable value.

Locally, wheat prices are stronger on the spot market as a result of very strong basis. Conversely, basis in the forward market is weaker.  ASX Jan-15 NSW Wheat futures currently sit at $285/t (blue line on figure 1).  Jan-15 ASX futures are at the lower end of wheat prices over the past 18 months, but are $91 above the weakest prices seen over the last 5 years, and about $75 below the highest price.  Jan-15 ASX basis to CBOT is at $25-30. This is historically strong, and reflects the reluctance of growers to forward sell at a discount to the spot market.

On a percentile basis, ASX Jan-15 futures are at the 61st percentile, so historically slightly stronger than CBOT wheat. This is largely a result of strong local basis.

What does this mean?

Due to possible local drought impacts on basis, we don’t recommend hedging on local futures or forward contracts, even though basis is historically strong. As such, we’re left with CBOT swaps and leaving basis open. With some volatility, the market could reach $270-280, which even with weak basis would result in wheat prices similar to those achieved this year. Accordingly, this is an initial target for wheat swaps.  If prices haven’t reached targets by the end of March, some cover should be taken at the $250-270 level, as the market is likely to reach the $210-230 level by later in the year.

If swaps are taken, cheap out of the money call options can be used to limit losses in the case of a supply disaster, which forces prices back above $300/t.  

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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