Tags: Commodities, Drought, Volatile, Wheat

Wheat's Forecasted Price Drop Highlights Profit Plays in Commodities

By , Money Morning •

By Mike Caggeso
Staff Writer

The doubling of wheat's price in the past year - combined with recent forecasts for price declines - have turned wheat's wholesome image into a volatile one. And depending on where you live, you'll hear a different story.

In Australia, the world's second-largest wheat exporter, droughts have cramped the yearly harvest so much that its Bureau of Agriculture and Resource Economics said the country would produce 31% less wheat (15.5 million tons) than it estimated back in June.

"Some of the estimates I've seen suggest if it doesn't rain by harvest time the crop could be as low as 12 million tons," Justin Smirk, a senior economist at Westpac Banking Corp., told Bloomberg News. "We have got a serious problem unfolding in the wheat regions in New South Wales."

Drought also took a chunk from the harvests of Canada (the world's largest wheat producer) and also the Ukraine. In Syria, the Middle East's lone grain exporter, drought swiped 4 million tons from this year's harvest. Meanwhile, its neighboring importers (and Japan) want to import more than 1.1 million tons of wheat.

In the United States, the U.S. Department of Agriculture is expected to estimate our biggest wheat harvest in three years, even though excessive rain damaged a portion of the harvest. Wheat's $7.7 billion annual value ranks it fourth among crops produced in the United States - behind corn, soybeans and hay. And half of the wheat grown in the U.S. market is exported, according to the USDA.

But taken together, global inventories of wheat are at a 26-year low. And that's why wheat prices peaked Wednesday at $9.1725 a bushel.

"We can not rule out $10 for wheat," Takaki Shigemoto, an analyst at Okachi & Co. in Tokyo who has been researching grain markets for 25 years, told Bloomberg. "Exporters are reducing the amount to curb domestic food prices, while importers are trying to secure as much grain as possible."

But What Goes Up...

So why are analysts also forecasting a wheat-price plunge when the global supply is being squeezed by harvest problems?

There's one basic truism about financial markets of all types that investors - and even actual market participants, such as farmers in the agricultural commodities market - can never seem to remember: The financial markets are forward-looking. That means that prices today are in part a reflection of what the future holds, both in the near-term and in the long-term.

That's why wheat prices are projected to soar. You see, instead of just watching wheat prices soar, farmers are planting more for next year's harvest. The projected oversupply could easily cause wheat prices to tumble 30% in the next year, analysts say.

A drop in wheat prices will relieve at least some angst at the cash register. Like corn, wheat is a ubiquitous staple of the American diet - it's a key ingredient in flour, bread, pizza dough, pasta, cereal, cookies, crackers, and more. With the dollar getting weaker and the price of oil soaring into the stratosphere, everyday consumers can celebrate a slip in price for wheat-related goods.

The same goes for wheat investors. Granted, prices will go down when supply is replenished, but wheat still remains an excellent long-term investment. If anything, wheat's price drop will be a great place to get in for investors who missed wheat's surge earlier this year.

Here's the easiest way to break it down. Wheat will always be in demand because people will always need to eat. As long as the world's population grows, investors of wheat - like corn, milk and all other agricultural commodities - will benefit.

For proof, consider China. The effects of wheat's soaring costs bleed into the cost for feeding cattle, poultry and pork. And that's helped send food prices soaring: Pork, for instance, is up 86% from a year ago.

Hundreds of millions of people in China are enjoying middle-class daily luxuries - such as dairy and meat - for the first time. And millions more will follow, not just in China, but also in India and Latin America. Since grain is a big part of livestock feed, this adds an enormous and previously unseen demand for wheat.

The higher costs associated with wheat - and the higher price for wheat in the marketplace - probably isn't just a temporary blip. Over the long haul, the price of wheat - like other agricultural commodities - is probably going to go up. So perhaps investors can offset the pain of higher food costs by profiting from the agricultural markets themselves.

Separating the Wheat From the Chaff

There are few "pure" wheat plays in the marketplace. And those heavily affected by wheat's price, such as Saskatchewan Wheat Pool (SWP) and General Mills, Inc. (GIS), are stuck between passing higher costs onto customers, and absorbing the costs themselves.

Neither are positive scenarios for investors. Instead, a better play is the source of wheat - farms.

Investors in Europe can tap wheat directly via ETF Securities Limited. Its wheat ETF is 100% allocated to the wheat market and is traded on the London Stock Exchange.

In the United States, the best investments opportunities are more diversified across the agricultural spectrum.

Deutsche Bank's PowerShares Agriculture Fund (DBA) is intended to reflect the performance of four commodities in the agriculture sector - soybeans (31.13%), wheat (28.87%), corn (23.43%) and sugar (16.58%). These include some of the key commodity plays that well-known investor Jim Rogers advocates. [To see what famed author and investor Jim Rogers has to say about wheat - and other agricultural commodities - please click here.]

Another is Van Eck's recently launched Market Vectors Agribusiness ETF (MOO). Like the PowerShares Fund, this reflects the agriculture industry but in a different way. Instead, the ETF's holdings reflect returns seen from agriculture chemicals (34%), agriproduct operations (33.5%), agriculture equipment (24.3%), livestock operations (5.6%) and ethanol/biodiesel (2.3%).

Besides, with a ticker symbol like that, how can you go wrong?

News and Related Story Links: