The ongoing war in Ukraine is causing dislocations between wheat ETFs and the underlying futures market as a supply-side crunch sends prices soaring.
Wheat futures have skyrocketed since Russia invaded Ukraine late month with front-month contracts hitting as high as $13.5 a bushel, 6% higher than the previous record set during the Global Financial Crisis in 2008.
Russia and Ukraine are responsible for approximately 30% of global wheat exports meaning the war and subsequent sanctions on Russia has caused logistical interruptions.
“Continued military action on Ukrainian soil could impact this fall’s harvest,” a research note from Jane Street said. “Additionally, Ukraine and neighbouring Belarus are large producers of major inputs into fertilisers so investors may be expecting agricultural production to feel a squeeze further down the line.”
In response, demand for wheat ETFs has soared. The world’s largest wheat ETF, the Teucrium Wheat Fund (WEAT) has seen $300m inflows over the past week alone, as at 10 March, according to data from ETFLogic, while the WisdomTree Wheat (WEAT) listed in Europe has seen $14.3m.
Flows into the US-listed WEAT were so large that it maximised the number of shares it could create without approval from the Securities and Exchange Commission (SEC).
As a result, the ETF has traded at a premium that is almost 90 times higher than its 1-year historical average, according to data from Jane Street, while WisdomTree’s WEAT jumped to an almost 12% premium to net asset value (NAV) in early March.
It is worth noting because WisdomTree’s product is swaps-backed rather than futures-backed, this meant it did not have to suspend creations, unlike the strategy in the US.
Furthermore, wheat futures have tight daily limits of around 5-7% of the futures price which can be triggered during volatile markets.
“While part of the premium may have been mechanical, a large part of the initial dislocation likely grew from difficulties in developing a fair price for the product,” Jane Street explained. “With wheat prices being at the up-limit, market participants could reasonably assume that the fair price for wheat was higher than listed, but there are few other sources of information giving traders a clear idea of precisely how much higher that price should have been.
“The creation halt [in the US] then impeded the arbitrage mechanism, which functions to keep ETFs in line with underlyings. Without this mechanism, demand for shares exceeded supply, leading to a further increased premium.”
While broader commodity ETFs are yet to suffer the same impact, the disruption in trading can lead to tracking error and is an important reminder of how unforeseen market dynamics can have a structural impact on ETFs like we saw with oil in 2020.