The KCBT-CBOT Wheat Spread’s Return To The Long-Term Norm

Wheat is the primary ingredient in bread, a source of nutrition for people worldwide. When asked which commodity is most political, most market participants would likely choose crude oil. With over half the world’s petroleum reserves in the politically turbulent Middle East, crude oil is the logical answer. However, a look back throughout history shows that wheat prices have far more political consequences than oil. 

While energy powers our daily lives, wheat provides the nutrition that allows us to survive. The primary responsibility of governments is to provide safety and essentials. When governments cannot feed the people, they have historically lost their power. The French Revolution in the 1800s began as protests over the rising cost of bread. More recently, the Arab Spring in the early 2010s began as a series of bread riots that gripped Tunisia and Egypt and spread across North Africa and the Middle East. In 2008, weather conditions led to a global wheat shortage, pushing wheat prices to all-time highs. Inflationary pressures following the 2008 global financial crisis pushed wheat to a lower high in 2011. 

Soft red winter wheat trades on the CME’s CBOT division. Hard red winter wheat trades on the CME’s KCBT division. 

Wheat is the latest commodity to take the bullish baton

In October, coal and natural gas held the bullish torch in the commodity asset class. Thermal coal for delivery in Rotterdam rose to a record $280 per ton. Nearby natural gas futures moved within 2.7 cents of the February 2014 peak when it traded to a high of $6.466 per MMBtu last month. Commodity prices have been on bullish paths in 2021, with lumber, copper, and palladium rising to record levels in May and many others reaching all-time highs throughout the year. 

In early November, wheat futures have taken the bullish torch, but they have been making higher lows and higher highs throughout this year. The most actively traded CBOT hard red winter wheat futures contract probed above the $8 per bushel level on November 1. 

As the chart highlights, the CBOT wheat futures rose to a high of $8.0700 per bushel, a level not seen since December 2012. 

KCBT hard red winter wheat rose to a high of $8.1450 per bushel on November 2, the highest price since May 2014. 

Meanwhile, spring wheat hit a high of $10.8650 per bushel on November 1, the highest price since June 2011.  Spring wheat has a high protein content of 13-16% and is used in artisan wheat products like hearth breads, rolls, croissants, bagels, pizza crust, and pastas. The spring wheat grows in the US in Montana, South Dakota, and Minnesota, areas of the US where adverse weather conditions have created shortages. 

Wheat prices have been climbing, which presents potential issues for the world. 

Hard red versus soft red winter wheat

The most liquid wheat futures contract is the Chicago Board of Trade’s soft red winter wheat contract. Soft wheat is a light golden colored wheat often called “white wheat.” Hard wheat is bronze-colored wheat with higher gluten content, making it the preferred ingredient in bread. Soft wheat has more starch and less gluten than hard wheat and is a good choice for cakes, pastries, desserts, and sauces. 

The CBOT soft red winter wheat contract is the benchmark for worldwide wheat prices, making it the most liquidly traded in the wheat futures arena. Meanwhile, burgers and hot dogs are a staple in the US, and bun production comes from the KCBT hard red winter wheat. The long-term average for the KCBT-CBOT wheat spreads has been a 20-30 cents premium for the KCBT over the CBOT wheat. However, over the past years, abundant supplies have caused CBOT wheat to trade at a premium.  

In 2019, KCBT wheat traded at a significant discount to CBOT wheat futures, departing from the historical norm. 

In 2020, the spread began narrowing:

On November 1 and over the past weeks, the spread began to flip to a premium for the KCBT hard red winter wheat over the CBOT soft red winter wheat: 

A look back to 2008 and 2012 when wheat reached highs shows that KCBT wheat commanded a substantial premium to CBOT wheat futures. 

The chart shows that in February 2008 and February 2011, KCBT wheat reached peaks at $13.8475 and $9.9050 per bushel. 

Meanwhile, CBOT wheat futures rose to highs of $13.3450 in February 2008 and $8.9325 in February 2011 as the KCBT premium was at a 50.25 cents premium in February 2008 and a 97.25 cents premium in 2011. Bullish periods in the wheat market pushed the spread to a $1 or higher premium for KCBT hard red winter wheat versus CBOT soft red winter wheat, the latter being the benchmark for worldwide wheat prices. 

The move over the past months is a sign of consumer hedging

Think of all of those hamburger buns sold at McDonald’s, Burger King, Wendy’s, In and Out Burger, Sonic, and the many other fast food establishments across the US. Purchasing managers at those companies tend to buy their wheat requirements on a formula based on the KCBT hard red winter wheat futures contract. 

When wheat supplies were abundant over the past years, the consumers purchased their wheat on a hand-to-mouth basis. As wheat was trending lower, there was little reason to hedge their future requirements. Meanwhile, the recent action in the wheat futures arena has flipped to a bullish trend, causing many consumers to return to the futures market to hedge against even higher prices over the coming months and years. Suppliers are likely offering consumers hedging options. As they lock in future costs, the hedges wind up in the futures arena. 

The bottom line is I view the trend in the KCBT-CBOT spread towards the long-term 20-30 cents premium for KCBT wheat as confirmation of the bullish wheat trend.   

Wheat is different than corn and beans

The US is the world’s leading producer and exporter of corn and soybeans. Meanwhile, wheat is another story as the US is one of many producers, with Russia the top exporter of the primary ingredient in bread. 
Russian dominance in the wheat export market only enhances its position in the commodity arena. As an unofficial but influential factor in OPEC, Russia has substantial pricing power in the global crude oil and wheat markets. The geopolitical impact of wheat and oil provides the Russians with significant control.  

WEAT is the CBOT wheat ETF product

The trend in wheat is higher as of early November 2021. Russian influence in the wheat market makes the bullish price action even more dangerous for worldwide consumers. Moreover, supply chain bottlenecks, supply shortages because of adverse weather conditions, and rising freight rates, make for a dangerous situation for the commodity that feeds the world. 

The most direct route for a risk position in the wheat market is via the futures and futures options that trade on the CBOT soft red winter, KCBT, hard red winter, and MGE spring wheat futures exchanges. When it comes to the worldwide pricing benchmark, the Teucrium Wheat ETF product (WEAT) provides an alternative for market participants looking for exposure without venturing into the futures arena. 

At the $7.63 level, WEAT had $79.89 million assets under management on November 3. The WEAT ETF charges a 1.91% management fee. WEAT’s fund summary states:

As of November 1, the ETF held long positions in CBOT December, May, and July 2021 futures contracts. Since the most volatile price action tends to occur in the nearby contract, the WEAT ETF tends to underperform nearby CBOT wheat futures on the upside but outperform during downside corrections. The most recent rally took December CBOT wheat futures from a low of $6.77 on September 10 to a high of $8.0700 on November 2, a rise of 19.2%.  

Over the same period, WEAT rose from $6.64 to $7.81 per share or 17.6%, as the ETF did an excellent job tracking the price of December CBOT futures. 

I view the return of the KCBT-CBOT spread to a premium for the hard red winter wheat as a factor that supports higher wheat prices. As wheat prices rise, it is another of the many reasons putting upward pressure on inflation.