By Todd Hultman
DTN Analyst
Just last week, the DTN National Cash Index of HRW wheat prices jumped up 18 cents to reach its highest close in six months. For those keeping a close watch on supply and demand estimates, it is difficult to believe that much can come out of last week's unexpected rally as the USDA estimate of world ending wheat stocks is at 34.1% of annual use, the most in 15 years.
I can't argue that the world is going to run out of wheat anytime soon, and I can't promise that wheat prices will be higher in 2017, but there is a case building for higher wheat prices in the next six to nine years. It is quite possible that last week's rally signaled an important change in wheat's long-term price cycle.
I can already hear some saying 'price' cycle? What kind of voodoo is that?
No, I am not counting sunspots, and I don't believe the ups and downs of grain markets are mathematically pre-determined. The cycles I am referring to are not necessarily predictable, but they can be seen historically and we can make guesses about where we are in the process.
Frankly, long-term commodity cycles are not well understood or they would be talked about more. Are they based on weather? Somewhat, although many commodities that are not weather-sensitive also show cyclic behavior.
There seem to be many sources of cyclic influence. Each commodity has its own production cycle that interacts with the larger economy. The credit cycle of financial markets and changes in the value of the dollar also affect the path commodity prices take.
When you get down to it, cyclic behavior not only governs external things, but also seems to be in our DNA. When prices are profitable, we become optimistic and produce too much. When prices aren't profitable, we still produce too much, but eventually lower our expectations and make changes.
After four consecutive years of good harvests, it is easy to forget how quickly things can change with less-than-ideal weather or some other unexpected event. We humans may not be good at predicting the future, but we are good at fighting the last battle, and the last two years have conditioned our expectations to be bearish.
Back in September 2015, I wrote "Taking a Long View," which explained how spot corn prices have difficulty staying below their 10-year average for long. All commodity prices, including grains, have a natural tendency to trade higher over time, which can be seen on any chart that goes back 30 years or more.
Not only is it unusual for commodities to trade below their 10-year average for very long, it is even rarer to see any major commodity trade at its lowest spot price in 10 years or more. In the case of Kansas City wheat, there have been only three such times since the low of 1968: 1986, 1998-99, and 2016. If this were horseshoes, we could also add 1990.
In the two cases prior to 2016, the 10-year low turned out to be an excellent buying opportunity. For producers, the 10-year low marked a long-term change in price direction that lasted as long as 10 years.
For those trying to understand why prices would go higher, note how the fundamental outlook is always bearish at the bottom. USDA's world ending wheat stocks to use ratio of 37% in 1986-87 came after five annual increases, and there was no guarantee at the time of not seeing six in a row.
The 1998-99 season was a little different in that the ending stocks to use ratio of 36% was also enhanced by an Asian recession that crippled U.S. grain demand. The 10-year low of $2.50 per bushel still marked the low end of the Kansas City wheat cycle in 1999, but it took a few years to pull out of the dive.
Coming off of a new 10-year low in 2016, there are plenty of reasons to be pessimistic about wheat prices. After all, world demand has only increased 20% over the past 10 years, and you can grow the darn stuff anywhere. It has the most diversified production of any major commodity.
However, with the world consuming 523 million bushels a week, we can't deny that wheat is needed, and at some point, producers will have to be paid for their efforts. Wheat production costs vary widely by region, but USDA estimates that it costs $241.90 an acre nationally, excluding land expense, or $4.60 a bushel based on 2016's yield of 52.6 bushels an acre.
I cannot guarantee wheat prices will be higher in 2017, but we should not ignore that the low wheat prices we saw in 2016 were uncommonly cheap by historical standards, and the fundamental markers of big supplies and bearish sentiment look a lot like the long-term lows we have witnessed in the past.
Best wishes in 2017.
Todd Hultman can be reached at todd.hultman@dtn.com
Follow Todd Hultman on Twitter @ToddHultman1
(BAS/SK)
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