WEAT - WEAT: Positive Catalysts Percolating Wait For A Buy
2023-05-01 20:18:22 ET
Summary
- The Teucrium Wheat Fund WEAT ETF provides exposure to wheat prices via wheat futures.
- The WEAT ETF should only be used for short to medium-term bets as it suffers from commodity futures roll decay.
- Several positive wheat price catalysts are percolating on the horizon that may trigger a buy on the WEAT ETF.
Back in November, I wrote a cautious article on the Teucrium Wheat Fund ( WEAT ), arguing that the headlines around a wheat shortage was unfounded, as global wheat markets appear balanced in my opinion. My simple stock/use model based on WASDE reported figures suggest there was significant downside to wheat prices. Based on stock/use ratio of 0.34 at the time, I estimated fair value for wheat prices was around $2.60 (Figure 1).
Figure 1 - Stock/use ratio suggested downside in November (Author created with price chart from stockcharts.com and data from USDA WASDE reports)
Fast forward 5 months and it is gratifying to see wheat prices converging to my estimate, recently touching an inflation adjusted low of $2.54/bushel (Figure 2). Essentially, the fear premium that was injected into wheat markets by Russia's invasion of Ukraine has been completely erased, as global wheat markets remained relatively balanced and absorbed the supply disruptions from the Russia/Ukraine war.
Figure 2 - Inflation adjusted wheat prices now inline with stock/use ratio (Author created with price chart from stockcharts.com and data from USDA WASDE reports)
WEAT Has Been A Terrible Investment
Due to the negative price action in wheat prices and the structural challenges of the fund, the WEAT ETF has been a terrible investment in the past few months, declining by over 23% since my November article (Figure 3).
Figure 3 - WEAT has declined by 23% since my article (Seeking Alpha)
As a reminder, the WEAT ETF does not hold physical wheat commodities; instead, it owns a basket of wheat futures that must be rolled at each contract expiry (Figure 4).
Figure 4 - WEAT ETF holds wheat futures (teucrium.com)
Due to the contango nature of commodity futures where longer-dated futures are higher in price, the WEAT ETF normally loses value during each contract 'roll'. So over the long run, the WEAT ETF vastly underperforms spot wheat prices, as shown in Figure 5 below.
Figure 5 - WEAT underperforms wheat prices in the long-run (Author created with price charts from stockcharts.com)
Upcoming Catalysts For Wheat Prices
With wheat markets in balance and wheat prices back inline with stock/use ratios, what is my outlook for wheat prices and hence the WEAT ETF?
Drought Conditions Persist In The U.S.
According to the latest Wheat Outlook report from the USDA, drought conditions in the U.S. remain a major concern for wheat production, as 48% of the U.S. is suffering from moderate or more intense drought (Figure 6). Although this figure has declined from the peak of 75% in November, the share of wheat acreage in drought is actually higher than at the same time last year.
As of April 9th, only 27% of the U.S. winter wheat crop is rated good/excellent, tying 1996 as the lowest percentage good/excellent rating at this point in the marketing year in the history of the dataset, which began in 1988.
If drought conditions persist, U.S. wheat crop yields could be negatively affected, which may drive up wheat prices in the coming months.
El Niño May Tighten Global Wheat Markets
In fact, U.S. drought conditions may be exacerbated in the coming months as the National Weather Services believe La Niña has ended and El Niño may be forming, beginning in the Summer of 2023 and persisting into the Winter. As a reminder, El Niño tends to cause areas in the northern U.S. and Canada to be dryer and warmer than usual, which could be detrimental to wheat production (Figure 7).
Figure 7 - El Niño could bring dryer and warmer weather to U.S. and Canada (NOAA)
Furthermore, El Niño conditions could bring dryer than usual weather to Australia, which may reverse 3 years of record wheat crops. In 2022/23, Australia produced a record crop of close to 40 million tonnes of wheat and was one of the main reasons global wheat markets remained roughly balanced despite the Russia/Ukraine conflict.
Russia/Ukraine Wheat Deal Extended For 2 Or 4 Months?
Finally, a potential catalyst for wheat prices in the coming months is the ongoing war between Russia and Ukraine. The start of the war in February 2022 sent wheat prices soaring to over $12 / bushel, as both Russia and Ukraine are major wheat producers and exporters. However, an export deal brokered by the United Nations and Turkey in July 2022 helped ease food security fears as it allowed food exports out of the Black Sea region.
This export deal has been continuously haggled over and was recently extended by 120 days, although Russia contends it only agreed to a 60 day extension, unless its own export of grains and fertilizers are also allowed to be exported. If Russia decides to revoke the export deal in May (when the 60 days is up), then food security fears may return to wheat markets once again.
Remain On The Sidelines For Now
For now, I recommend investors remain on the sidelines on the WEAT ETF, as wheat markets remain in balance and prices are inline with stock/use ratios. However, if prices were to fall further into undervalued territory based on the stock/use ratio model, or if one of the catalysts highlighted above were to come to fruition (U.S. drought, El Niño reducing Australian crop, Russia revokes Black Sea export deal), then I believe investors can play the WEAT ETF for a short-term trade.
For further details see:
WEAT: Positive Catalysts Percolating, Wait For A Buy