In a mid-October 2022 Barchart article, I wrote:
The metric I watch for clues about U.S. wholesale U.S. wheat consumer behavior is the spread between KCBT hard red winter and CBOT soft red winter wheat. Many U.S. bread manufacturers price their requirements from the KCBT contract. When the premium for KCBT wheat against CBOT wheat rises, it signifies supply and price concerns. The spread tends to rise when wholesale consumers increase their hedging activity, locking in price levels and assuring supplies.
On October 12, the KCBT versus CBOT premium at 94.50 cents per bushel on the nearby CBOT futures contracts was far higher than the long-term 20-30 cents average but below the record high.
While CBOT wheat futures prices have steadily declined over the past months, the KCBT premium continued to rise.
A bearish trend in CBOT wheat futures
CBOT wheat futures reached the $14.2525 per bushel all-time high in March 2022 when Russia invaded Ukraine, turning Europe’s breadbasket and critical logistical hub at the Black Sea ports into war zones. While the battle for Ukraine continues to rage, CBOT wheat prices have steadily declined.
The chart highlights the pattern of lower highs and lower lows that took the most liquid wheat futures to a $5.9550 low in May 2023. Wheat remains in a bearish trend, at just under the $6.10 level on May 22, but the price is higher than the level from August 2015 through September 2020. Wheat’s war premium has declined, but the price remains elevated.
The KCBT-CBOT spread rises to record territory
While the most liquid CBOT soft red winter wheat futures have declined, the premium for KCBT hard red winter wheat soared.
The chart ({KEN22} - {ZWN22}) shows that from 1970 through 2022, the average level of the KCBT – CBOT spread was between flat and a 50 cents premium for the KCBT hard red winter wheat. The spread tends to rise when wheat prices and supply concerns increase because many U.S. bread manufacturers and food processors price requirements on formulas tied to the KCBT wheat price. Therefore, when wheat prices fall or remain stable, the demand for consumer hedging declines as they purchase wheat on a hand-to-mouth basis. However, when prices and supply worries rise, consumers rush to the futures market to hedge requirements, pushing the KCBT – CBOT spares higher.
The chart shows the move to an over $2.50 per bushel premium for KCBT hard red over CBOT soft red winter wheat futures in May 2023, a record high.
As of May 22, the forward curve shows the following spread values over the coming months in 2023:
- July- $2.1425 per bushel premium for KCBT wheat
- September- $1.9475 premium for KCBT wheat
- December- $1.6925 premium for KCBT wheat
The premium for the hard red winter wheat futures over the coming months is at record highs, at least quadruple the long-term average for the spread.
What is the spread telling us?
The KCBT – CBOT spread is a barometer for price and supply fears in the wheat market. The move to a record high, the previous spread peak was below $1.50 per bushel, is a warning sign that at $6 per bushel, CBOT wheat futures are far too low.
While it is impossible to pick bottoms in any futures market during a bearish trend, CBOT at $6 per bushel, with the KCBT futures at over $8 per bushel for the same delivery month, is a compelling reason to own the CBOT wheat futures, which are the most liquid benchmark wheat futures contracts.
The bottom line is the spread is flashing a buy signal.
CBOT wheat is in the buy zone for three reasons
Aside from the spread, at least three other reasons make CBOT wheat futures at the $6 per bushel level a bargain:
- The May WASDE- The USDA’s May World Agricultural Supply and Demand Estimates Report stated U.S. and global wheat stockpiles are falling, with the worldwide stocks-to-use ratio at the lowest in nine years.
- Europe’s breadbasket- The USDA expects Russia to be the world’s leading wheat exporter but stated that Ukraine would suffer a 21% decline in wheat output because of the war. Moreover, Russia’s production will drop on the reduced area and yields from last year’s record harvest.
- Inflation- Global inflation at the highest level in decades causes all agricultural input prices to rise. Land values, labor, financing expenses, fertilizer, equipment, and other costs of goods sold items have soared, putting upward pressure on the price farmers must receive to produce the crops that feed the world.
While CBOT wheat’s technical picture remains bearish, the fundamentals suggest the price will reach a bottom where it runs out of downside steam and turns higher sooner rather than later.
WEAT is the ETF product
The most direct route for a risk position in the CBOT wheat market is the futures and futures options offered on the Chicago Mercantile Exchange. Meanwhile, the Teucrium Wheat Fund (WEAT) tracks the price of a portfolio of CBOT wheat futures on the up and downside. WEAT typically owns three contracts to minimize roll risk, so it often underperforms nearby CBOT wheat futures on the upside and outperforms on the downside. The most volatility and price extremes tend to occur in the nearby contracts that attract the most speculative interest. WEAT’s construction smooths the ETF’s price volatility by incorporating contracts for three delivery periods.
At $6.14 per share on May 22, WEAT had over $156.6 million in assets under management. WEAT trades an average of 649,461 shares daily and charges a 0.22% management fee.
After a decline from over $14 per bushel in May 2022 to the $6 level in late May 2023, wheat is in the buy zone where fundamentals favor a significant bottom. Leave room to add on further declines, as it is impossible to pick absolute bottoms during any bearish trend.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
