There has undoubtedly been a disparity happening in commodity markets. The action started in late 2023 and has so far continued into the second quarter of 2024. Weather and inflation have both had a major influence over the divergence in market action. What does that mean for commodity markets going forward? Good question.
Weather this past year has been dominated by the El Niño weather pattern. As a result, it has created a volatile year across agricultural markets. Some areas of the world were impacted by high temperatures and drought conditions while others were dealt too much rain. Overall, a seemingly clear trend emerged with the southern hemisphere suffering a bigger disruption than the north. In turn, it helps explain the widening gap this year between the performance of agricultural commodities, softs being on one side of the pendulum while grains are on the other.
Courtesy / NOAA
Three of the five soft commodities — cotton, coffee, and sugar — moved to multi-year highs (since 2011) in 2022-23. In late 2023, orange juice reached a record high with cocoa and coffee rising to historical highs just this week. As a result, soft commodities were the best performing sector in 2023 and in the first quarter of 2024 — all based on weather as top producing areas including Asia, West Africa and South America have been exposed to extreme conditions.
In the past we have seen similar weather markets impact grain futures. Unfortunately, this past year, the weather pattern resulted in ample supplies of corn, soybeans and wheat. In turn, prices have responded accordingly to both situations. Just remember, supply and demand driven markets are volatile. Similar to the correction grains experienced since the start of the year, soft commodities will likely see a sizable correction when the supply and demand story shifts. This is just one part of how market dynamics work.
At some point, demand will come into play. High prices tend to cure high prices and low prices tend to cure low prices. Right now, many soft commodities are still sitting on or near record high prices which at some point will lower demand for many end users. Eventually the higher prices will be passed on to the consumer which could quickly impact demand across the sector. For soft commodities, this may last longer than the market suspects. With many soft commodities reliant on trees for production, supply could take years to re-establish depending on weather severity. For example, cocoa trees typically take three years to establish. With that, this market could experience significant demand destruction for a longer period of time compared to grains. Again, the cure for high prices will eventually be high prices.
That doesn’t bode well for inflation, especially as soft commodities have begun to be driven by speculation. For example, the 18-month rally in cocoa has been historic but prices and consequently the capital required to trade cocoa is so high that most speculators have left the market. A similar situation played out in orange juice. Remember, the funds are strictly trend followers. They enter a market to purely make money. When they believe they have pushed the market as far as it can go, they exit and look for the next trend. In searching for the next potential bull market run, many have decided to buy the coffee market. What commodity market is next?
With grain prices still sitting at or near three-year lows, the sector seems well poised. Again, low prices usually cure low prices. Eventually, demand will be sparked as the world chews through current ample supplies. It’s also important to note that the funds are still holding large net short positions in all three major grains. This should have been a trend we all jumped on. So far, being short has been a winning position but eventually, that will change.
Traditionally, investors tend to focus on financial assets such as equities. However, there are benefits to diversifying into commodities during times of inflation. Commodities are considered a hedge against inflation due to their intrinsic value and tend to perform well when prices for consumer goods rise. Equities, on the other hand, tend to perform poorly during periods of inflation as it tends to decrease cash flows for companies due to effects of inflation (higher interest rates and input costs). In 2022 when inflation was rising, commodity markets outperformed equity markets led by crude oil, despite the strengthening U.S. dollar.
Typically, commodities and the U.S. dollar have an inverse relationship. This is mainly due to the U.S. dollar being the preferred currency for global commodity trade. As a result, a higher U.S. dollar implies weaker commodity prices. However, during times of inflation, both can be driven higher. If history repeats itself and another round of inflation takes place (similar to the 1970 and 1980s), the current market situation could be the calm before the storm.
The only thing we are missing is a catalyst. However, the market has plenty of black swans looming overhead, the most recent being the tensions escalating in the Middle East. Arguably, this will not have a large impact on grains or soft commodities but it certainly could in the energy sector. With inflation and added geopolitical tensions becoming a reality, it seems the flight to commodities could be landing sooner rather than later. Let’s also not forget that the global weather pattern is changing. La Niña will likely bring a new set of commodity supply and demand issues.
Allison Thompson is a market analyst with The Money Farm in Ada, Minnesota. She previously has worked as a Farm Business Management instructor and is active on her family’s Mahnomen, Minnesota, grain farm.
Allison Thompson is a market analyst with The Money Farm located in Ada, Minnesota. She previously has worked as a Farm Business Management instructor and is active on her family’s Mahnomen, Minnesota, grain farm. She recently purchased The Money Farm and has turned her experiences in the fields and classroom into a career where she is able to help producers facing the challenges of today’s markets.
