Health Wealth Matters

Time to Buy Call Options on Wheat

Written by Dr. Wealth on September 2nd, 2010

Russian drought news has been the dominant factor in the grain market this summer. Wheat prices began to rally in early June as commercial traders fully supported the lows around $4.50 while accumulating a net long position of over 80,000 contracts. At this time, the Russian drought news started to hit the wires. The month of July was fueled by the day-after-day weather reports across Europe as this turned out to be the worst drought in 50 years. Wheat prices sky rocketed to $8.41 by August 6th and have since been in a trading range between $6.45 and $7.34 while waiting for further assessment of the weather’s impact on this year’s crop.

Facts are now replacing hyperbole. It has been reported that Russian wheat will be off by 31% along with a carryover effect to a winter wheat crop that will also be off about the same amount late this year. Global wheat production is expected to be around 660 million metric tons for 2010. Russia was expected to produce around 60 million bushels and will end up closer to 40 million metric tons. Considering ending stock surplus is around 175 million metric tons as of the end of 2009, Russia’s 20 million ton shortfall should be easily covered.

Now that the actual numbers are starting to come out, there are three important points to be made in this example.

1)   The futures markets are totally democratic. Everyone has access to trade them and the prices represent global supply and demand. This means that farmers all over the world compete to create the best available bids and offers. This also means that local farmers have access to the best global bids and offers and therefore, are not tied to the local grain elevator operator’s basis offers $.60 – $1.50 below the futures price. This is exactly the type of market inefficiency that the exchanges were created to eliminate.

2)   There have been nine years in the last 25 when global wheat production did not exceed global wheat consumption . The surplus that was created by 16 year’s worth of excess production makes up the global ending stocks and provides the cushion necessary to make up for anomalies like Russia’s drought. In spite of sporadic annual wheat deficitis over the last 25 years at no point have global wheat ending stock dropped below 50 days’ supply.

3)   Following the commercial traders provided actual trading opportunities while the media fueled hysteria with headlines like, “Global Warming Killing Crops, “ “Worst Russian Drought in 50 Years,” and “Russia Imposes Ban on Exports,”etc. Commercial traders went from long 80,000 contracts when they collectively felt that wheat was undervalued below $4.75 to currently short 10,000 contracts. The 90,000 contracts sold represent commercial wheat traders’ analysis of their market and the consensus of all of the fundamental factors affecting it. Their actions can also be seen through technical analysis that shows the wheat market stopping dead at the 38% Fibonacci retracement level from the January ’08 highs over $15 to the lows at $4.40.

The next actionable clue to future movement in the wheat market will be seen in technical analysis that points to a retracement to $6.05. This represents a 50% retracement from the $8.50 highs to the $4.40 low. We will combine our technical expectations with commercial trader’s actions through this consolidation between $6.45 and $7.34 to form a cohesive trading plan involvingboth technical and fundamental analysis that cuts through the media’s noise and allows us place trades based on proactive action rather than reactive reaction.

See the first “Interesting Formation ” to view the accompanying chart. Registration is free.

Andy Waldock publishes this blog.  Andy Waldock is a financial advisor, asset manager, trader, analyst and brokerfor Commodity & Derivative Advisors, located in Sandusky, Ohio.  Therefore, Andy Waldock may have positions for himself, his relatives, or his clients in any commodity future market discussed. The blog is meant for educational purposes and to develop a discussion among those with an interest in the commodity future markets. The commodity markets employ a high degree of leverage and commodity trading  may not be appropriate for all investors.  Investing in the commodity futures could result in considerable risk.  If you are interested in reading other published articles, commenting  on his publications or subscribing to Andy’s blog, please visit http://blog.commodityandderivativeadv.com, or if you have any questions, please call 1-866-990-0777.}

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