A producer called and said, “Kim, I did something that I probably shouldn't have.” He has sold six Kansas City Board of Trade (KCBT) July 2008 wheat contracts at $6.96. Using a 45 under (-45¢) basis, he had hedged 30,000 bushels of wheat for an expected price of $6.51. Not bad!
His concern was that, at the time of the call, the KBCT July contract price had just closed at $7.62¾. He had received a total of $20,025 in margin calls. The second question was, “How high can the KCBT July 2008 contract go?”
As if I knew the answer, I said “$9.50.” That would be a total margin of $12,700 per contract or $72,200 for six contracts. The historical high KCBT nearby contract price is $9.50.
Three more questions were discussed. What was causing wheat prices to increase? How low could the KCBT July go between now and June 2008? And, what should he do?
Wheat prices are being driven by tight U.S. and world wheat stocks. The stocks-to-use ratios (wheat ending stocks divided by use) are record or near record lows. United States ending stocks are projected to be about 312 million bushels, the lowest since 1948. In 1948, total U.S. wheat use was 1.4 billion bushels and the stocks-to-use ratio was 22.5 percent. The 2007-2008 wheat stocks-to-use ratio is projected to be 13.6 percent.
The world's wheat ending stocks are projected to be 4 billion bushels and the stocks-to-use ratio is projected to be 17.8 percent. These are the lowest ending stocks since 1977 when the stocks-to-use ratio was 27.6 percent.
Argentina and Australia's wheat harvest are nearing completion. Argentina and Australia's wheat production have been factored into current prices and there is little chance that anything will happen in Argentina or Australia to impact wheat prices between now and June.
The U.S. winter wheat crop is the next exportable wheat crop to be harvested and the world must have our wheat. Because of this demand, wheat prices should remain relatively high into the July time period.
A U.S. wheat crop above 2.2 billion bushels will probably end up with higher ending stocks and stocks-to-use ratio for the 2008-2009 marketing year. Wheat production below 2.1 billion bushels will probably result in ending stocks about the same as this year.
For prices to decline, an area from the Texas Panhandle to southwestern Oklahoma up through western Kansas must receive rain before a severe freeze, or 60 degree plus days and 20 mile per hour winds.
If the dry areas receive moisture and favorable growing conditions, the KCBT July wheat contract could decline to the low $6 range. Every dry day lowers the odds of the KCBT July contract price going below $7.
At this writing, the best information that money can buy says that the KCBT July wheat contract price during June 2008 will be $7.78. That is where the July contract closed. Experience tells us that, in June 2008, the KCBT could be between $6.50 (or lower) and $9.50 (or higher).
This implies that June 2008 Oklahoma or Texas cash prices could be between about $6 and $9. The market is currently offering about $7.23 (-55¢ basis).
What should a producer do? My answer is nothing!
The reasoning is: for prices to decline, 2008 U.S. wheat production must be higher than current expectations. That means producers will have more wheat to sell at a lower price than is offered today.
If prices go higher, then 2008 production will be lower than is expected today. That implies that producers will have less wheat to sell at a higher price.
Prices and production partially offset each other. The offset is not perfect and the weather and the market does not impact all producers the same.
The other suggestion is, “make decisions that allow you to sleep.” If you lie awake worrying about lower prices, price some. If you are going to lie awake worrying about making margin calls — do not hedge.