Sugar, beef and other commodities
A re-entry opportunity?
The summer is here and it looks good with covid continuing to decline in the US and Europe. The tail wind from warmer temperatures appears to be helping along our (limping) vaccination effort. I have stated before that we will find it tough to achieve herd immunity and covid may well return this fall, but that is more an issue for stocks. It is less relevant for commodities which are driven by demand and supply.
The demand is certainly there, perhaps nowhere more so than in the Leisure and Hospitality industry. Small wonder that agricultural commodities underlying L&H businesses have been on a tear this year - the Bloomberg Agricultural Commodity Index is up 20% YTD. But that begs the question, why is now a good entry point?
My story goes like this. First, the April jobs report came out on May 7th, hinting at stagflationary pressures. Since then agricultural commodity prices declined instead of rising even as short-term inflation expectations went up and over 300,000 jobs were added to the Leisure and Hospitality sector. So why did prices fall? My view is that profit-taking by informed traders may have caused momentum traders i.e. CTAs to sell off large positions. Here’s how: given the economic uncertainty revealed by the jobs report and commodity prices at their peaks, some commodity insiders decided to take money off the table. But their profit-taking left CTAs with large and loss-making agricultural positions. They would have had to sell, regardless of fundamentals, possibly creating an oversold situation. This sort of thing impacts agricultural markets more than energy or metals because they have less volume.
Aside from internal market dynamics we have other fundamental supply issues going on. Brazil is currently experiencing its worst drought in 20 years which has ravaged it’s sugar and coffee production. Corn may well follow. While this adds calories to the sugar trade, there is yet another supply factor building up: covid-related restrictions in Brazil are easing, which means more transportation and less sugar available for export. This is because Brazil uses enormous amounts of sugarcane-based ethanol as replacement for gasoline.
Another big player in the global sugar market is India, which I think may be a bit of a wash right now: covid related lockdowns have created logistical issues around sugar exports which could impact supply. But at the same time there is less traffic at restaurants and sweet-shops which could free up more sugar for export. So I see India as a bit of a wild card that bears watching - it could tilt the sugar scales one way or the other.
Let’s look at the beef market. Argentina recently announced a snap 30-day ban on beef exports, in a (possibly) misguided attempt to control beef inflation before the fall elections. Beef inflation is a serious issue for Argentines as they consume more of it per capita than anyone else. They also happen to be among the five largest beef exporters and China’s biggest supplier. But this is not the only reason why the global beef market is becoming tighter. China is hit on one side by the Argentine beef ban and on the other it’s pork population is experiencing a new wave of African swine fever, which makes substitution with beef attractive. Meanwhile, New Zealand’s cattle season is drawing to a close, Indonesia has (also misguidedly) banned frozen buffalo meat from India and cattle feed such as corn could become costlier. This puts considerable pressure on US and Australian beef production.
All in all, it looks like supply pressures are once again growing in agricultural commodities while demand is only likely to increase. Meanwhile prices have dipped. If prices do begin climbing again, momentum traders will have to either reverse their short positions or at the very least lever up again, which could cause yet another price surge.
Thus, I like this re-entry point into agricultural commodities. With apologies to the title of this post, I also like soybean products, coffee and corn in addition to sugar and beef.
Commodity futures are the most common way to take positions in these markets, but I was pleasantly surprised to see that a firm called “Teucrium funds” is offering single-commodity ETFs namely CANE, CORN, SOYB etc. As far as I could tell though these ETFs have lower liquidity and worse performance than futures contracts, so I wouldn’t want to trade those unless I have to. More diversified agricultural funds such as Invesco’s DBA fund are also available with higher liquidity.
As always, there are more than a few macro risks here. The next two weeks are going to be heavy with news on inflation and jobs, starting with the PCE report this Friday. After the enormous jobs miss in April, I am all for being very respectful of economic uncertainty.
Ergo, stop-loss orders on new trades can be a good idea.
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