After a big rally in May that saw export prices approach $300 a tonne, wheat markets slid back sharply over the next six weeks, sinking as of mid-July to their lowest levels in two years. Although investor sentiment toward commodities, equities and the economic outlook once again spurred the price volatility, grain fundamentals played a key role in the downturn.

During this period, wheat export values dipped by more than 20%, fueled by harvest pressure in the U.S., a generally favorable outlook for the global crop and prospects for ample wheat stocks. In its late June report, the International Grains Council (IGC) projected 2009-10 global ending stocks at an eight-year high, while the U.S. Department of Agriculture (USDA) a few weeks later also forecast the highest level of stocks in eight years, in terms of both tonnage and stocks relative to use.

It its report, the USDA projected 2009-10 world wheat production at 656.5 million tonnes. Even though that figure would be 4% less than the 682 million tonnes harvested in 2008-09, it still would be the second largest crop on record.

As for global wheat demand, the USDA forecast 2009-10 world wheat consumption at a record high 642.6 million tonnes, about 1% higher than the previous record of 636.2 million set last season. But with consumption lagging output for the second straight season, stocks at the end of 2009-10 should expand to 181.3 million tonnes, compared with 167.4 million at the end of 2008-09, with the stocksto-use ratio rising to the eight-year high of 28.4%.

Among key wheat suppliers, Australia’s crop is forecast to increase by about 7% as the worst drought in many decades continued to ease. But Canada and the E.U. should post year-on-year harvest declines of 18% and 11%, respectively, based on various weather problems during the growing season.

In the U.S., the winter wheat harvest moved into high gear in late June, and despite awful results in the southern Plains, the Kansas hard red winter wheat crop came in well above expectations, in terms of both quantity and quality. Consequently, the USDA in July raised its U.S. wheat crop estimate to 57.5 million tonnes, down 15% from the 2008-09 crop, but 5% higher than earlier projections.

Although Argentina should see a slight year-on-year increase in wheat production, the country will fall far short of its typical output. From 1998-99 through 2007-08, Argentina produced an average wheat crop of 15.3 million tonnes a year. The 2008-09 crop plummeted to 8.4 million tonnes, while the 2009-10 crop should increase to only 9.5 million.

Extreme weather conditions, including drought and cold temperatures, account for some of the staggering decline from average in the past two seasons, but more significant is the drop in Argentine area planted to wheat. The IGC and the USDA estimate wheat area for 2009-10 will be in the range of a scant 3 million to 3.5 million hectares, the smallest since 1951.

Argentine area historically planted to wheat has shifted to other more profitable crops, particularly soybeans. The USDA noted a major impetus for falling wheat production might be the government’s habit of unexpectedly imposing export restrictions and taxes on wheat.

Those actions have created uncertainty for farmers, jeopardized export sales and cut into wheat profitability. They also may have encouraged a shift to crops less affected by government intervention, the USDA said.

The IGC and the USDA both project a decline in world wheat trade during the 2009-10 season, with their forecasts dropping by 10% and 11%, respectively, from the previous season. But that decline comes after wheat trade set a record high in the 2008-09 marketing year just ended, spurred by drought in the Middle East that led the region to more than double its wheat imports.

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