During a 26-day trading period, the KC March wheat contract price lost an average of 6.5 cents per day ($7.06 to $5.36). The price crashed through support levels at $6.60, $6.40, $6.10, $5.84, and $5.60 and bottomed out at $5.33.
After hitting bottom, KC March wheat traded between $5.33 and $5.50 for four days. Then, in one day, the price increased 27 cents. Was the price increase due to changes in the wheat supply and demand situation or because market funds were buying KC wheat contracts? Indications were that little change occurred in the supply and demand situation. The funds were offsetting short (sold) contract positions by buying contracts.
Market funds became an integral part of commodity market systems in 2006 and 2007. Market funds have billions of dollars invested in the commodity markets (short and long positions), and changes in fund positions tend to increase price volatility. This effect is both good and bad for producers.
The good news is, like KC wheat prices on February 3 when the funds bought contracts, the result was a 27-cent price increase. This increase provided an opportunity for producers with wheat in storage to take advantage of higher prices.
The bad news is the KC March contract price may not have declined to $5.33 if the funds had not been selling KC wheat contracts.
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Market and index fund investments in KC wheat do influence prices in the short-run. In the long-run, supply and demand expectations set price levels. Fund, speculator, hedge, and cash trades cause the price to fluctuate above and below the equilibrium price.
If market fund trading results in prices being above the price equilibrium, wheat importers will buy from other sources, and U.S. wheat prices will come back down. If market fund trading results in wheat prices being below the price equilibrium, wheat importers buy U.S. product, and the price goes up to the equilibrium price.
Producers can manage increased price volatility by selling wheat over time (dollar cost averaging) rather than selling it all at once. Some sales will occur when the cash price is above the equilibrium level and some will occur when the price is below the level. By staggering sales, relatively low prices are offset by relatively high prices. Producers then receive an average market price.
Another strategy is to sell wheat on rallies. If your strategy is to sell a specified amount of wheat at a certain time period and the wheat price rallies 27 cents in one day, at the minimum you should sell a portion of the wheat.
At this writing, wheat prices are relatively low with the KC July wheat contract price near $5.60. The major reason the KC July contract price is at $5.60 rather than $6.60 is because the value of the U.S. dollar is about 18 percent higher than it was in late June and early July.
Market factors (such as the value of the U.S. dollar relative to other major currencies) impact wheat prices more than market fund trading. The difference is that fund trading may move the price above and below the equilibrium. The value of the dollar affects quantity demanded and shifts the market equilibrium price up or down.
Market funds and other outside factors will continue to influence prices. Producers should remember that no one can consistently predict price movements. One method to counter fund trading and changes in the value of the dollar is to set target prices and/or sell dates and then have the discipline to follow through with the plan.