The graph below shows the HGCA
delivered prices for the latter half of the last marketing year and this year. To estimate the ex-farm price the cost of haulage, about £3-6/t, has to be deducted from the delivered price.
Delivered price wheat East Anglia (£/t) (Source HGCA)
The graph illustrates the exceptionally long period when even an "expensive" option, or minimum price contract would have left the grower better off (to sell without the benefit of an option, or minimum price contract, would have left the grower even better off but this would have been a risky strategy without the benefit of hindsight). Thus even in January 2009 an option (e.g. sale with call option, or put option and deferred sale) for the 2009 harvest would have left the grower better off than now appears to be the case. Fengrain, and no doubt others, were offering minimum price contracts of £110-120/t in January providing a more cost effective solution than a conventional option strategy albeit with some loss of flexibility.
Currency was at its weakest on 30 December arguably increasing price by about
20% compared with the previous September albeit against a fundamentally falling market. The
January 2010 futures price has changed almost exactly in line with the
strengthening currency since January this year. Prices since June until January had
been higher than would have been expected from the monthly revised stock
estimates.
Exchange rate US Dollar per £ (Bank of England)
Note that the influence of currency is the inverse of above: as sterling strengthens the price of wheat (and other commodities priced in dollars) falls. The UK price was massively supported by the weakening sterling in the first 6 months of he year. The dollar price of wheat as represented by the nearby position on the US CBOT (Chicago Board of Trade) market for soft wheat showed a different picture much more closely relating to the supply and demand.
CBOT nearby futures price $/t
For most of this period the stock estimate for 2008/9 was increasing and consequently "global" prices were falling. Traded prices are invariably calculated in US dollars. Later in the year prospects for the 2009 harvest began to influence prices. Most analysts recognised that the 2009 production was unlikely to show the exceptional increase shown in 2008. The 2009 grain crop yields were well above the short and long-term trend-lines and it seemed unlikely that a) the weather would be as favourable b) that crop inputs would fall i) the ratio between input and out prices had deteriorated particularly for fertiliser ii) the credit shortage would squeeze purchase particularly in areas such as FSU and South America.
However, the other impact of the recession was on demand. Historically, the increase in demand has shown far less variation than supply (largely determined by population growth). In addition, in recent years the use of crop in biofuels had possibly accelerated the rate of increase in demand. This year has proved an exception and in fact the USDA revised their consumption estimates and forecasts for both 2009/9 and 2007/8 as the year progressed and consequently expectation for 2009/10 should have been lower.
This year at least so far the production is as we, and no doubt others, forecast last autumn but we also over estimated demand.
As at July 2009 we are not confident that there will be an increase in total closing grain stock for 2009/10 although the USDA estimates suggest a small increase. In addition, the most of the major exporting countries are still expecting a fall in production and consequently fall in exports. Consequently, the dollar price is unlikely to change significantly from the 2008 marketing year. However sterling is already much stronger than it was last January and if the current forecast are correct we would expect to see a fall in the sterling price of wheat. There is also a
risk that UK farm prices in November will fall dramatically since there is a
vast carry over of crop both on farm and with other stockholders because of the extraordinary price differential between old and new crop particularly in June and July. I assume that most of this will have been sold again for
November taking up space which would usually have been filled with grain needing to be moved more quickly.
There is still a
chance of further recession
which might mean that exchange rate will weaken driving up UK grain price. The quantative easing (printing money) used to stimulate the economy
should also result in a weaker sterling exchange rate if, as it would be expected to do, it increases
the risk of inflation. (The theory is that while the additional money supply should stimulate manufacturing it is unlikely to stimulate production sufficiently to absorb the extra cash and with more money than goods the cash becomes devalued - i.e. inflation occurs). Conversely, the only weapon to prevent inflation is to increase interest rate in order to reduce expenditure. If the increase in interest rate prevents inflation there is a risk that it will strengthen sterling. This is unlikely to occur but remains possible. This is
one of the many situations when subtle changes drive events in the opposite
direction.
In
a worst case scenario, where exchange rate returns to September 2008 levels and
supply and demand roughly equals last year, the ex farm price would be around £70-75/tonne.
With 2010 prices still higher than 2009 a forward sale maybe worthwhile with or without an option. Even at current prices profit is likely to be secured but may not be if price falls to £75/t. Futures and options prices and costs can be obtained from http://www.liffe.com/reports/eod?item=Daily)
In practice when using a call option strategy the physical crop sale should be as far forward as cashflow and storage allows, assuming that the price carry is greater than teh valu eof teh cash, while the call option may be
for a shorter period (such as January 2011) to cover the greatest period of volatility. The closer period for the option reduces cost while the later sale increases return. There is of course a trading period that is uncovered although a second option might be taken out at the close of the first option if thought to be worthwhile. Where quality grain is grown a similar safeguard can be put into place using a put option. The physical crop is not sold until quality is known and the put position closes securing the minimum price.
