How do we know when irrational exuberance has unduly escalated asset values?--Alan Greenspan, 1996

The market can stay irrational longer than you can stay solvent.--John Maynard Keynes, 1931

The history of the world shows that there never has been a time when there was a great demand for anything, whether it be a product of the mine, factory, or farm, that sooner or later a supply in excess of that demand did not develop. This is but a natural law.--W.D. Gann, 1928

The Minneapolis Grain Exchange (MGE) is the nation’s smallest commodity exchange. The MGE has only one actively traded commodity futures contract: spring wheat. The volume in spring wheat futures routinely dwarfs that of the larger exchanges. (The highest volume wheat contract resides in Chicago.) But in the past few weeks, the MGE market has exploded.

This year spring wheat is the hottest market in the world, exhibiting price moves of historic proportions rarely seen in any market anywhere, anytime. The action in the spring wheat pit (and on electronic screens) has been feverish; some would call it irrational. Just this month alone, spring wheat futures fortunes have been made and lost. And it all may not be over yet.

What caused Minneapolis wheat to reach the highest price ever paid for a bushel of wheat in the history of the world? My plan here is to first provide you with some background, then summarize how this market got to where it is now. And, finally, I'll go out on a limb with a prediction.

There are three major varieties of wheat traded on the US exchanges.

The most plentiful variety is hard winter wheat traded in Kansas City. This type of wheat is used for bread and grown in a number of states, primarily Kansas, Texas and Oklahoma. The Chicago variety is soft winter wheat used for cakes and pastries, grown in areas like Missouri and Illinois. The spring variety that's traded at the MGE is primarily grown in North Dakota but also South Dakota, Montana and Minnesota. Unlike the winter varieties, as its name implies, spring wheat is planted in the spring and harvested in late summer. It’s a premium, higher-protein variety used in baked goods such as French bread and hard rolls.

Last year, wheat farmers in North Dakota and Minnesota, lured by the biofuels promise of potentially higher corn and soybean prices, planted more of those crops while reducing their spring wheat acres. The weather was less than ideal in the Dakotas that summer, and the result was a short crop. Add in crop failures around the world (from Australia, Europe, Russia and the Black Sea), and this combination of events combined to create the lowest level of world wheat supplies in more than 60 years.

This year the global supply of wheat as a percentage of usage is only 18 percent, the lowest number since World War II. Additionally heat stress, experienced by wheat crops globally, has resulted in lower protein levels. This scenario has created even greater demand for the already short Minneapolis variety: a perfect storm. Smaller supplies and greater demand resulted in not just a sharp gain in the Minneapolis futures prices, but Minneapolis spring wheat also gained dramatically in relation to the Chicago and Kansas City varieties.

Although millers can substitute different wheat varieties for many applications, spring wheat is required in the blending of higher-protein bread types. And it’s the variety most prized by the Japanese (who import most of their spring wheat from the US).

Earlier this month, the Japanese entered the marketplace looking for 80,000 tons of spring wheat. They only received offers for 50,000. This was a wake-up call to wheat traders who started to believe the US just may be sold out of spring wheat with six months until the next crop becomes available. The result was a buying panic.

It’s hard to put these numbers in their proper perspective, but I'll try.

Until 2007, the all-time high price for Minneapolis wheat was $7.23 per bushel, hit briefly in May 1996. Just a few months later, as the new crop became available, the price was back under $4 per bushel. For seven years following 1996, wheat prices weren't able to again trade for more than $4 per bushel.

For the majority of those years, it was rare to see a $1-per-bushel move for an entire year. In contrast, the price of spring wheat was able to rise more than $4 per bushel in just one week, and that was last week.

Minneapolis Wheat 1995 to February 2008

Since the first of the year, Minneapolis wheat prices have risen above $10 per bushel. On Friday, Feb. 8, prices in Minneapolis moved up more than $4 per bushel in just one day. The exchange has found it difficult to cope with this high degree of volatility.

The old rules (recently changed) restricted the daily price movement to a limit of 30 cents per bushel per day. During the recent frenzy, this rule placed an artificial restraint on prices; the futures market had to stop trading at the limit. However, the cash market for spot delivery could still trade freely, and by using option pricing techniques, traders could simulate the actual (freely traded) price in the futures. When you glance at the daily chart of March Minneapolis wheat, it appears tamer than it actually was in the thick of this battle.

March 2008 Minneapolis Wheat (Daily Chart)

To date, the all-time high traded price was recently made on Feb. 8: $22 per bushel in the March contract. However, people who study the daily chart see a high price of $15.53 for that date. This discrepancy is because the contract was restricted from trading more than 30 cents above the Feb. 7 price of $15.23. But, in reality, there was no trading at that price on that day. The actual price was determined via cash and options and was in the stratosphere--in the $20-to-$22-per-bushel range.

This is called a synthetic price because the contract never traded this high. However, trades were being transacted on this day at these prices on both sides synthetically.

What do these numbers mean in real dollars? A futures contract for Minneapolis wheat is a standard size: 5,000 bushels. Therefore, every penny-per-bushel movement in price is equivalent to a $50 profit or loss per contract traded. The margin requirement for one contract at the start of this move was $1,500. (Subsequently. it's been raised to $7,150.)

Margin in futures is like a good faith deposit and is returned to the trader when he or she exits, plus any profits or minus any losses. So a limit move of 30 cents returns the equivalent of $1,500 per contract to the trader on the right side and subtracts this amount from the player on the wrong side. If the market moves more than this number, the additional margin money is added to the account of the winner and must be deposited by the loser to his or her account.

At the beginning of this year, the March contract was trading at the all-time high price of $10 per bushel. This recent move from $10 to $20 represents an incredible $50,000 profit or loss for just one contract in just a few months. The $4 move on Feb. 8 alone equaled $20,000 on just a single contract in one day.

In the real world, expect to pay more now for a premium loaf of bread or a Kaiser roll. So who benefits from a price move like this? Other than the traders who are on the right side of the market, you can feel good for those farmers who held onto some of their production from last year’s crop or sold in double digits last week; these guys are big winners.

However, there weren’t many because the nature of a market like this is that the great majority of farmers sold out their wheat inventories months ago. Why not take that $10 per bushel in January, the highest price ever seen in history to date? And that’s why there's dearth of spring wheat today. There's always some wheat lying around that hasn't been sold yet, although these are the scarce bushels owned by few. Still, there will be some farms in North Dakota this year with new pickups, new tractors, new combines and new planting equipment.

To recap, this price move in Minneapolis wheat has been unprecedented. To cope with the volatility, the MGE has now put in place a new limit policy. Limits now can expand from 30 cents to 60 cents then to 90 cents and all the way up to $1.35 based on a formula contingent on how the market traded the day before. And the initial margin deposit required to trade one contract has been raised from $1,500 before the volatility began to $7,150 today.

Last Friday, Feb. 15, the March Minneapolis contract hit an all-time high for any wheat contract anywhere, anytime when it traded as high as $19.80 (but still under the synthetic high of $22 from Feb. 8). It closed slightly below this high at $19.35, marking a new all-time high close.

What now?

I don’t know if the March contract will be able to make a new high or not. After all, top picking is very difficult, and this market is overheated. I do believe that there's a real shortage of this variety of wheat that can't be alleviated for months, at least until the new crop comes in.

And right now the new crop hasn't even been planted yet. And although some millers are willing or able to substitute cheaper wheat varieties, the Japanese (the biggest buyer of US export spring wheat) have indicated they're price insensitive. I’ve heard they're willing to pay up to $50,000 for one premium blue fin tuna, so $20 for a premium bushel of wheat may not seem that out of line.

Bottom line: This shortage appears to be real; there's a dearth of premium, high-protein wheat available right now, and it will likely take enormous prices to squeeze those remaining bushels out of the woodwork that may still be out in the country. As a result, I believe prices will be well supported on any break. I also believe farmers in the Dakotas and elsewhere will be planting spring wheat fencepost to fencepost this spring.

Wheat is a cheaper and easier crop to grow than corn or soybeans. And, at these prices, why plant anything else? This is why the September contract is trading at a big discount to the March contract right now. By September, barring any adverse weather, the current shortage should be alleviated.

Actually, it gets quite interesting when you analyze the futures prices month by month. And I see a dramatic opportunity unfolding in this market right now.

Here are the closing prices by month from Friday, Feb. 15:

* March Minneapolis--$19.35
* May Minneapolis--$15.61
* July Minneapolis--$12.00
* September Minneapolis--$10.67

The new crop (planted this spring) will be harvested before this contract comes due for delivery. The July contract is an old crop month but close in time to harvest. And by then the Kansas new crop will be available to the market.

But what about the May contract? Why is it trading fully at $3.74 per bushel lower than the March contract? Will there be more spring wheat in May versus March? No.

The reason has to do with money: the recent squeeze to the March contract. Traders caught short in the March contract have had to scramble to cover at the prevailing price, and March more closely reflects the cash price for immediate delivery. Also, for technical reasons, some short traders rolled their short March contracts into May (by buying the March contract and simultaneously selling the May contract) because they couldn't liquidate the March contract outright when it was locked up to the limit. I believe they're merely deferring their pain by this action.

Bottom line: I see a huge opportunity to buy the May contract at the current big discount to the March price. There will no longer be additional spring wheat supplies come May. And, in terms of supply, May could be even tighter versus March because two additional months of usage will be gone. Unless spring wheat comes from a new source of which we're currently unaware, I see the May contract eventually trading up to the March price.

This isn't certain, of course. We're still dealing with the unknown, but this is my prediction. Remember a $3 move returns $15,000 per contract. This would be more than a 200 percent return on margin in just a few months.

However, this is a very volatile, very risky market right now. In fact, this market is so risky that, although I'm trading it for my own account, I don't plan to issue a Minneapolis wheat trade recommendation to the Futures Market Forecaster trading service subscribers at this time.

This isn't a mainstream market right now, and I think such a recommendation would be inappropriate for many traders. Therefore, I caution you as strongly as I can. If you're not very well capitalized and also willing to take a high risk for the possibility of a very high return, stay away from this market at this time. (It will still be interesting to watch over the coming few months, however).

On the other hand, if you're willing to assume a high risk and think you may want to play for the prospect of substantial rewards, feel free to e-mail me at, and we can discuss the risks and rewards a bit more.

Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the Holy Grail. Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.

Hypothetical Performance

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.