Nasty Draught Pushes Grain Prices

08/26/2011 8:00 am EST

Focus: COMMODITIES

A very poor wheat harvest and increased global demand has already propped up grain prices, and if the pattern continues, look for buyers to target the futures markets and a particular grain ETF.

Last fall, we witnessed a dramatic rally in wheat after the third-largest producer/exporter, Russia, experienced its worst drought in 50 years. It had spent the three years prior expanding its list of export customers by offering wheat at a discount to its competitors as a way of becoming a major world player in the exploding world food demand cycle that still continues.

Russia was forced to suspend its exports, however, leaving customers scrambling to find a port to purchase wheat, and quickly pushing prices from $4.50 to $8.50 per bushel. Could we be witnessing the beginning of another major world producer/exporter possibly experiencing a similar production disaster?

US Drought

The US is the largest producer/exporter of wheat in the world. A drought in the southwestern winter-wheat-producing states of Texas, Oklahoma, and Kansas began last summer. It led to the worst winter wheat crop in 20 years.

The winter wheat crop ended with 63% of the crop in fair to very poor condition. Its survival to that point came only as subsoil moisture was still there. However, the drought continued and today is considered the worst in 100 years.

Range feed is so scarce that ranchers have put record numbers of cattle onto feed yards to be fattened on corn for the last two months. Crop insurance companies are not willing to offer crop insurance at this point on new acres, and growers are saying they will not plant unless the weather pattern changes.

We typically see 35% of the crop planted by mid-September and 50% or more by October 1. Current forecasts see the dryness and intense heat continuing into October.

What to Expect

There certainly is time, though little, to see a sharp and dramatic weather pattern change, but large trading funds already are sweating over the implications of the drought continuing.

Three weeks ago, trend-following funds were holding short positions of 54,000 contracts, then 52,000 the next week, and 45,000 entering this week.

Should the drought continue, so too will the buying back of 45,000 contracts along with new long position holders. This looks to keep the December wheat contract moving higher with a target at its major chart resistance of $8.70.

chart
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Outside of the futures market, wheat can also be played with an ETF, although exposure to other grains like corn and soybeans would be part of the deal.

The PowerShares DB Agriculture Fund (DBA) is the most liquid of the agricultural ETFs.

Here’s a daily chart:

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Click to Enlarge

By Tim Hannagan, senior grains analyst, PFGBEST Research

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