Wheat investors are feasting on a double-digit rally, but take care before you bite

Bread, it is said, is the staff of life. Or at least it was, before beating up on gluten became all the rage. But whatever your dietary choices, if you'd been investing in bread — or, more precisely, the stuff that goes into it — over the past few weeks, you'd be feasting on a pretty satisfying repast right now.

Prices for wheat futures have been soaring. In little more than a week after June 27, July futures at the Chicago Board of Trade (the most liquid wheat derivatives market in the world) rose about 20 per cent; even after a mild correction afterwards, they have still enjoyed a 15-per-cent-plus rally since late June. That increase has taken place against the backdrop of a mini-recovery in grain globally: the World Bank grain price index in June was up almost 10 per cent from April. But wheat has been leading the pack.

For investors confronting stalled or weakening equity markets over the past few weeks, those kinds of returns might look delicious. If you're among those worried about nascent inflation — which our central bankers seem to think must be just around the corner, somewhere — then it's worth noting that investing in agriculture has historically been a sound hedge. And bargain hunters might be tempted by the fact that while almost every asset class these days is priced for perfection (or even divine ascension), grains have been in the price toilet for a long time.

In that context, the recent wheat rally might seem counterintuitive. Last year, farmers in Canada and the United States managed record-high yields — but the rest of the world did, too, so prices plummeted. The hangover is still there, in the form of very high global reserve stocks, which according to the U.S. department of agriculture (USDA) are set to decline only marginally.

So why are prices rising For anyone who thinks farming is a simple business, the answers will give them another think. And they point to why the uninitiated might want to tread carefully before wading into the wheat pool, either directly or through one of several agriculture-related exchange-traded products on the markets.

The simple reason for the recent rally is the stunningly complex confluence of unpredictable events grouped under the heading of “weather.” Drought has stricken wheat-producing areas of the U.S. Midwest and High Plains, and the USDA estimates that as a result total acreage sown for 2017 will be down nearly 10 per cent from last year. In Canada, there is severe to moderate drought throughout much of breadbasket southern Saskatchewan. In Ukraine, abnormally dry weather is likely to push down yields, and droughts in parts of Australia could translate into an estimated 30-per-cent decline in production from last year — it could be the smallest crop in a decade for one of the world's major wheat exporters.

All this is good news for prices, but they have been given an added boost, at least in North America, by the fact that not all wheat is created equal.

We don't normally think of wheat as an important source of the bodybuilding material, but to those who actually use it (as opposed to investing in it) protein levels can be crucially important. To make the kind of bread people want to eat, for instance, you need flour that's relatively high in protein. Hard wheat has it; soft wheat doesn't. And buyers pay a premium for higher protein content.

That premium has been rising. Last year's bumper crop resulted in lower protein content across the board — which makes sense, when you figure that the same level of nutrients had to go into a greater number of plants. Then, in May, a late snowstorm hit Kansas, the largest wheat producer in the States, severely affecting yields of hard winter varieties. That's contributing to an estimated 23 per cent decline in winter wheat production overall, according to the USDA.

Another wrinkle: low prices (thanks to last year's record production) meant that farmers spent less on fertilizer, meaning lower soil nutrient levels, meaning less protein in this year's crops. In Kansas, one May survey suggested the protein content of winter hard wheat could drop by more than half a percentage point this year.

So where can flour-makers and bread-bakers turn Well, there's hard spring wheat, which (as the name implies) is grown in spring; it has the highest protein content of all U.S.-produced wheats. Trouble is, it's grown primarily in Montana, Minnesota and the Dakotas — areas that, thanks to the aforementioned drought, are having challenges of their own.

Put it all together, and it's bad news for protein-rich wheat yields and great news for protein-rich wheat prices. On the Minnesota Grain Exchange, the principal market for hard red spring wheat, futures have risen by almost 50 per cent since mid-May.

That's a big jump. But it also demonstrates how volatile agricultural commodities can be — not just because their markets are so damnably complicated, but also because the factors that cause price movements can be relatively obscure, seemingly minor and inscrutably complex. The important question for investors is whether the recent wheat rally signals a real turning point, or just a passing panic

Who knows You might as well ask whether how much it's going to rain next month in North Dakota.

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