Crop setbacks coupled with a high level of short positions held by speculators have left wheat prices vulnerable to a spike similar to last spring's, when the market surged by one third in a little over a month, Rabobank has said.

The bank cut to 660m tonnes its forecast for world wheat output in 2010-11, reflecting in the main the worsening prospects for the harvest in Canada, where heavy rains have prevented farmers from planting up to 12.5m acres of crops, and flooded much of what has been sown.

"Weather developments in Canada over recent weeks have possibly been the most damaging of any of the recent setbacks for world wheat production," a report from Rabobank's City office said, cutting its forecast for the country's crop to 20.5m tonnes.

That implies a 23% slump in production in the world's second biggest wheat exporting nation.

Black Sea decline

Furthermore there was "increasing evidence" that exportable surpluses out of Black Sea states would be lower, thanks to high winterkill rates.

"Yield expectations have also been lowered, with tighter credit conditions leading to reduced applications of fertiliser and chemicals," the briefing said.

And downgrades to the European Union crop look unlikely to be the last following hot and dry conditions in many northern parts, but notably in France, the region's biggest wheat producer.

EU supplies were also "somewhat tighter than anticipated" thanks to a jump in exports fuelled by the slide in the euro, which had made the region's grain more affordable to foreign buyers.

'Not as benign'

Further rallies in wheat, now that a "more balanced fundamental outlook" for the market is on the cards following the sharp surpluses of the last two years, may force speculators to close some of the considerable short positions they have in the grain.

This could result "in a short covering rally, causing a spike in prices similar to that in [spring] 2009". Prices then gained 33% between late April and a June 1 high.

Prospects for Minneapolis-traded wheat, which is of the spring variety suffering the bulk of the Canadian setback, looked particularly promising, even after already growing its premium over Chicago wheat by more than 70% over the last two weeks.

"Reduced spring and durum wheat production in Canada may lead to further strengthening between the Minneapolis and Chicago markets," Rabobank said.

Meanwhile, a rise in volatility in both markets "suggests the global wheat market may not be as benign as we have seen in the past two seasons".