- Soft commodities declined in risk-off conditions in Q1
- Four of the five soft products posted losses during the first three months of 2020
- FCOJ posts a double-digit percentage gain
- Cotton is the leading loser during the quarter
- Sugar, coffee, and cocoa prices decline
Soft commodities can be the most volatile sector of the commodities market as prices routinely double, triple, or halve in value during their pricing cycles. The path of least resistance for the prices of luxury commodities is a function of the weather and crop diseases in the critical growing areas around the world. However, the demand side of the fundamental equation reflects an ever-increasing addressable market for these products as the population of the world is growing by 15-20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by approximately 27.3%, which amounts to over 1.640 billion people, according to the US Census Bureau. More people with more money consume more coffee, cocoa, sugar, cotton, and orange juice each day, which underpins the prices of these commodities. However, the outbreak of Coronavirus in Q1 weighed on all markets, and soft commodities were no exception.
The composite of five soft commodities, sugar, coffee, cocoa, cotton, and frozen concentrated orange juice, posted two straight years of gains in 2015 and 2016. At the end of 2017, soft commodities were down just 2.25% on the year. In 2018, they finished with a loss of 5.68%. In 2019 the soft commodities sector moved 3.47% to the upside. In Q1 2020, soft commodities posted a 8.79% loss for the three months.
The dollar index moved 3.16% higher in Q1, which weighed on the prices of all commodities. The dollar moved considerably higher against the Brazilian real in 2018, and the real remained weak throughout 2019 with other emerging market currencies. In Q1, the real fell to a new and lower low below the $0.20 level. Brazil is the world’s leading producer of three of the five commodities in the sector, including sugar, coffee, and oranges. The weak real was not supportive of the prices of the three products in Q1 as it fell below the bottom end of its trading range. The dollar is the reserve currency of the world and the benchmark pricing mechanism for most commodities, including those of the soft or tropical variety. However, the weather is always the most critical issue when it comes to annual crop sizes and the direction of prices.
Like all agricultural commodities, demographics continue to provide an ever-increasing base of support for these food products. With wealth rising in the world’s most populous county, China, competition for food continues to increase, which puts a strain on supplies. As we head into Q2, it will be the weather and crop issues that determine the path of least resistance of prices as demand will continue to favor higher lows. However, the impact of demand can be slow and steady while supply gluts or deficits tend to shock markets and cause the most significant price moves on both the up and the downside. The outbreak of a global pandemic that caused a deflationary spiral in Q1 will continue to impact the demand for soft commodities in Q2. At the same time, the potential for export problems from producing countries, particularly in South America and Asia, could create shortages that would increase price volatility. Bullish and bearish factors face most of the commodities in the sector, going into the second quarter of 2020.
While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes just under a 19% exposure to the three of the most active in the sector as it holds positions in sugar, coffee, and cocoa futures contracts. The soft commodity sector rose in Q4 and 2019. However, Q1 presented a unique set of challenges for the sector. The prospects for Q2 depend on the weather, the overall state of supplies, currency markets, and, most significantly, the global pandemic.
Sugar was 28.02% higher in 2016 and gained 4.96% in 2015. In 2017, the price of sugar lost a total of 22.3% of its value. Sugar was 20.65% lower in 2018 compared to the closing price at the end of 2017. In 2019, sugar was 11.55% higher. Ample supplies of sugar had caused the commodity to make a series of lower highs and lower lows from 2011 through August 2015 when the sweet commodity traded down to 10.13 cents per pound. Sugar then proceeded to rally, making a series of higher lows and higher highs culminating with the highs in late September 2016 at 23.90 cents per pound. From late 2016 through the end of September 2018, the sweet commodity moved lower, making a series of lower lows reaching a bottom at 9.83 cents per pound on the nearby ICE world sugar futures contract in late September 2018, as the nearby ICE futures contract was expiring. Sugar rebounded to 14.24 in October 2018. In 2019, the price dropped to a higher low of 10.68 in September before moving steadily higher to a higher high of 15.90 cents in mid-February. Risk-off conditions in all markets pushed the price to a low of 10.40 at the end of March. Sugar traded in a range of 10.40 to 15.90 cents in Q1 2020. Nearby sugar futures that trade on the ICE settled on March 31, 2020, at 10.42 cents per pound as it moved 22.35% lower in Q1 and settled near the low for the period.
Sugar prices traded as high as 36 cents per pound in February 2011. In countries like the US and the EU, the price of sugar is subsidized by the government. However, the major sugarcane producers, Brazil, Thailand, and India, sell their crops at world market prices. Even in these countries, the government occasionally adopts policies to support sugar producers.
In Brazil, the weakness of their currency, the real, contributed to a depressed sugar price. Brazilian producers were dumping sugar into a falling market in dollar terms, but as the real moved lower, the price of sugar in Brazilian currency had done much better. The Brazilian currency fell to a new and lower low in Q1, and the price of ethanol plunged in Q1, which was not supportive of the price of sugar. Ethanol fell to a new record low at under 90 cents per gallon in March 2020. Ethanol moved 33.75% lower in Q1 on the back of a significant decline in gasoline and crude oil prices. While the US refines corn into biofuel, Brazil processes sugar into ethanol. The level of the real against the dollar fell below the $0.20 level in Q1. The Brazilian real declined from $0.25050 against the US dollar at the end of Q4 2019 to $0.19185 at the end of Q1 2020. At the same time, crude oil plunged from $61.06 per barrel at the end of Q4 to the $20.48 level at the end of Q1, which was an extremely bearish factor for the price of sugar since it is the primary ingredient in the production of alternative fuel in Brazil. Gasoline fell to the lowest price of this century on demand destruction during a deflationary spiral.
After five straight years of surplus conditions, the sugar market went into a small deficit in 2015/2016, and that imbalance had increased in the 2016/2017 crop year. The price of sugar rose to 23.90 cents per pound in October 2016, which was the peak. The higher price caused an increase in production, and the deficit turned into a surplus in the sugar market, which weighed on the price throughout 2017 and much of 2018. At the same time, the Brazilian real declined against the U.S. dollar, falling from 0.32 in 2018 to under the 0.20 level in 2020, which puts additional pressure on the sugar price.
As the weekly chart of the Brazilian currency against the dollar shows, the real plunged from 0.3200 against the dollar in late January 2018 to a low of 0.18680 in Q1 2020. The plunge in the value of the currency that is the world’s leading producer and exporter of free-market sugarcane caused the domestic price to remain stable or even rise as the dollar-based price declined. Brazil was able to sell sugar into the market regardless of the low price for the soft commodity, which added pressure to the price and sent sugar to a low of 9.83 cents in late September 2018 and to 10.40 in Q1 2020. In Q4 2018, the real recovered to a high at 0.28000 in late October as a far-right-wing and anti-corruption leader won the Presidency. The election of Jair Bolsonaro led to a rebound in the currency against the dollar, which provided additional support for the sweet commodity and drove the price to a high at 14.24 cents per pound during Q4 2018. The real ran into selling at the highs. The real declined from a lower high at $0.27475 in early Q1 2019, which helped to push the price of nearby ICE sugar futures to around the 12.50-cents per pound level. In Q3 2019, financial problems in neighboring Argentina and fires in the Amazon weighed on the value of the real, which fell to a low at $0.23375 in late November 2019 before recovering. In Q1 2020, the real fell to a new all-time low in an environment where the worst risk-off situation since the 1930s gripped markets. The weakness in the Brazilian currency contributed to a decline in sugar over the first three months of 2020.
Meanwhile, this year, sugar rose to a high of 15.90 per pound in early February as drought conditions in Thailand stoked fears of supply shortages. The sweet commodity rose to its highest level since May 2017 before risk-off conditions caused the sharp correction to 10.44 cents per pound in March. A toxic bearish cocktail of a decline in the Brazilian real, plunging gasoline prices, and risk-off conditions pushed the price of sugar back towards the multiyear low. However, the sweet commodity held above the 10 cents per pound level.
The sugar market was mostly in contango at the end of Q1 2020, where deferred prices were higher than nearby prices on the forward curve.
The forward curve in sugar futures highlights contango from May through March 2021 and slowly drifts higher out to October 2022. The forward curve offers clues about the balance between supply and demand. The nearby prices indicate no supply concerns because of the decline in energy prices. Sugar cane for delivery in 2021 and 20222 is not planted, and the weather, and crop or political events or changes in policies can alter the forward curve significantly and very quickly when they occur.
The quarterly chart of ICE sugar futures shows that since sugar fell to a low of 2.29 cents per pound back in 1985, the price had made higher lows during periods of oversupply. In 1985, there were 4.85 billion people on the earth, and at the end of Q4 2019, that number stands at over 7.640 billion, an increase of over 57.5% over the past thirty-five years. The number of people on our planet has increased exponentially over the past three and one-half decades, which has increased demand for all agricultural commodities, and sugar is no exception. The quarterly chart remains in oversold territory when it comes to price momentum.
The monthly chart shows that price momentum was falling below neutral territory. Sugar is moving into Q2 with the Brazilian currency on the lows and both the commodity and the currency were in downtrends.
As the weekly chart illustrates, price momentum was heading into oversold territory at the end of Q1.
Weather conditions in primary growing regions around the world have created more than enough sugar to satisfy global demand, which sent the price to the lowest level in more than a decade in 2018. The weak Brazilian currency and increased Indian subsidies also helped sugar move lower in 2018 and 2019. Subsidies and tariffs tend to distort commodities prices as they interfere with supply and demand fundamentals. Economic theory teaches that commodities flow from those producers with the lowest output costs to consumers around the world. Those producers whose cost of output is above the price buyers are willing to pay do not survive. When prices fall to a level where production declines, inventories begin to fall in response to growing demand. Demand typically increases at lower prices, which leads to a decline in inventories when output slows. The price action in Q3 and rebound in Q4 2018 were signs that sugar reached the bottom of its pricing cycle, which led to its recovery. In Q1, drought conditions in Thailand lifted the price to 15.90 cents before risk-off conditions created by the Coronavirus sent the price lower.
Moreover, at a time when demand destruction gripped the crude oil market, OPEC and Russia decided to flood the market with the energy commodity. Crude oil dropped to below $20 per barrel, and gasoline below 40 cents per gallon on the nearby futures contract. The combination of factors weighed on the price of sugar and sent the price from 15.90 to 10.40 cents per pound on the nearby futures contract. Sugar ended the first quarter at the low as Coronavirus continues to be the worst pandemic to grip the world since the 1918 Spanish flu and price of crude oil remained near the low.
Meanwhile, production subsidies or tariffs interfere with the fundamentals of efficient markets. Therefore, supply and demand analysis become challenging in markets where governments support businesses that are losing money or where they restrict the flow of goods around the world. When government-subsidized products flood international markets, they damage economic conditions in other nations where governments do not provide aid to producers.
Open interest stood at 989,858 contracts at the end of Q4 2019 and increased to 1,015,678 contracts at the end of Q1, a rise of 25,820 contracts, or 2.61% over the three months. The metric rose to over 1.260 million contracts in Q1 when the price was one the high, which was an all-time peak. Open interest dropped during the risk-off period as speculators moved to the sidelines, and the price fell. While declining open interest and the decreasing price is not typically a technical validation of a bearish price trend, March 2020 was not a typical time as Coronavirus and a flood of crude oil combined to create a potent bearish cocktail for the sweet commodity.
Sugar can be one of the most volatile commodities that trade; in past years, daily historical volatility had exceeded 100%. At the end of Q1, daily historical volatility stood at 32.28%, which was 20.94% higher than it was on the final day of trading in Q4 2019. As we move forward into Q2, technical support for sugar stands at 9.83 cents per pound, with resistance at 15.90 cents per pound, the Q1 peak.
Sugar Outlook for Q2 2020
The break below the August 2015 low in 2018 was the result bearish fundamentals coming together when it comes to the Brazilian real, government subsidy policies in India, and cooperative weather conditions in growing regions around the world. These factors created an almost perfect bearish storm for the price of sugar that tool the sweet commodity to a low of 9.83 per pound in Q3 2018. In 2019, the low was higher at 10.68 cents, but the high was lower than in 2018 as sugar only made it to a peak at 13.67 cents during the final month of last year. In Q1, sugar rose steadily to 15.90 cents, the highest level since 2017, when a black swan event hit markets across all asset classes like a ton of bricks, and sugar was not except. The dry conditions in Thailand and concerns over a supply shortage took a backseat to a global pandemic and decision by the international oil cartel, together with the Russians, to flood the world with crude oil. Sugar dropped like a stone to a lower low at 10.40 cents and closed the first quarter not far above the low for the period.
Looking forward to Q2, uncertainty in all markets and all aspects of life in the US and around the globe was at the highest level in our lifetimes. A continuation of the pandemic could cause logistical issues that lead to shortages and periods of price spikes. Meanwhile, a deflationary spiral sent the price of ethanol in Brazil and the level of the Brazilian real to new record lows. We should expect lots of volatility in the sugar market as well as in all markets in Q2 as we are in uncharted territory when it comes to world health and asset prices. Once science comes up with effective treatments and a vaccine, the economic fallout will remain a problem for many years. The cost of the global pandemic will run in the many trillions boosting deficits and caused currency values to decline. The potential for inflationary periods, together with stagnating economic growth is higher over the coming months and years. The longer Coronavirus remains a problem, the more extensive the financial challenge will become. When it comes to sugar, we could be in for a period of significant dislocations in the market, which will enhance price volatility. However, the rising population of the world will continue to require the crops that provide nutrition. Sugar is an ingredient in many foods that all people on the planet consume each day.
The critical levels of technical support stand at the recent low at the 2018 bottom of 9.83 cents, and then at 9.44 cents per pound, the June 2008 bottom. Below there, 8.36, the June 2007 low will be the next level on the downside. The environment at the end of Q1 tells us to expect the unexpected in sugar and all markets and asset classes over the coming months. The potential for lower prices is high.
For those who do not trade in the futures and futures options market on the Intercontinental Exchange, two ETN and ETF products do a reasonable job tracking the price of futures in the sweet commodity. SGG is the ETN product, while CANE is the ETF. I tend to prefer ETFs to ETNs because the later makes the buyer assume the credit risk of the issue. CANE holds long positions in ICE futures contracts. Since the ETF has a blend of three contracts, and the most volatility tends to occur in the nearby futures contract, CANE often underperforms the price action on the upside and outperforms on the downside on a percentage basis. I prefer ETF products to ETNs because I’d rather assume the price risk of the commodity without additional risks that may result in surprises. The ETF offers a more direct route to the price action in the commodity without the extra level of risk.
The price of crude oil and gasoline, the level of the Brazilian real versus the US dollar, and most importantly, the state of Coronavirus and its impact on the world will dictate the path of least resistance of the sweet commodities over the next three months and beyond. We are in unprecedented times, and we should expect wide price variance in the sugar market as the soft commodity has a long history as one of the most volatile agricultural products with a price range from 2.29 to 66.00 cents per pound since the 1970s. The concern on the downside is a continuation of the deflationary spiral. On the upside, logistical and production issues caused by the virus and the prospects for inflation on the back of a tidal wave of stimulus from the world’s central banks and governments could cause the prices of all raw materials to move higher as currency values move in the other direction.
Coffee was the number one, the best-performing commodity of 2014, registering a gain of 43.19%. In 2015 it was the worst-performing soft commodity. Coffee futures fell 23.95% in 2015 but recovered by 8.17% in 2016. In 2017, the price of coffee moved 7.92% lower. The price of coffee moved 19.29% lower in 2018. In 2019, coffee futures moved 27.34% higher. In Q1, the price of coffee declined by 7.83%. Nearby ICE coffee futures closed on March 31, 2020, at $1.1955 per pound. The price range in Q1 was from $0.9740 on the lows to $1.3310 on the highs. Coffee declined from January through early February and recovered in February and March and closed the quarter above the midpoint of the trading range for the period.
The weekly chart highlights that coffee futures had been in a bear market since November 2016. In Q4 2018, coffee violated the pattern of lower highs, and lower lows as the price rose to $1.2550 and above a level of technical resistance at the early June 2018 high at $1.2495 before turning lower once again. In Q4 2019, the price rose significantly above the October 2018 high. At the end of Q1 2020, coffee futures were working their way back towards the late 2019 peak. Meanwhile, price momentum and relative strength on the weekly chart were just above neutral readings at the end of Q1.
The daily chart of the active month May ICE coffee futures contract illustrates that price momentum had declined from overbought territory after the most recent peak.
Meanwhile, the monthly chart displays a market where price momentum turned higher after rejecting the low at 86.35 cents per pound in April 2019. Open interest had been trending higher with the bearish price action, which was a technical validation of the downward trend in the coffee futures market. However, it fell in Q1 because of risk-off conditions in all markets on the back of the global pandemic.
Open interest in coffee futures moved lower over the past three months. Open interest stood at 277,161 at the end Q4 and fell to 240,712 at the end Q1 2020, a decline of 36,449 contracts, or 13.2% over the first quarter of 2020. Open interest rose to a new record high at the start of Q2 2019 at over 357,000 contracts.
Coffee futures were still in contango at the end of Q1, a sign of some oversupply in the coffee market. However, the price of coffee rallied over concerns about an off year for production in Brazil, the world’s leading producer and exporter of Arabica beans. The International Coffee Organization said that the 2019/2020 crop could be low compared to recent years, stoking fears of the supply-demand deficit in the global coffee market. Meanwhile, coffee could face the same logistical and production issues like sugar and all commodities in the face of the worldwide pandemic as we head into Q2.
Starbucks (SBUX) and Dunkin’ Brands Group (NASDAQ: DNKN) are both significant consumers of coffee beans, and the soft commodity is a primary cost of goods sold component for their earnings metrics. The massive selling in the stock market sent the prices of both SBUX and DNKN shares substantially lower. The price moves in the two stocks had little to do with the Arabica coffee futures market over the past three months.
As the chart shows, DNKN stock moved from $75.54 per share at the end of Q4 to $53.10 and the end of Q1 2020, a decline of 29.71% over the three months. DNKN shares moved to an all-time high at $84.73 on September 5, 2019 and tanked in Q1 as the black swan event hit markets.
Shares of SBUX also moved lower in Q1 for the same reason but outperformed DNKN.
As the chart shows, SBUX shares slightly lower from $87.92 at the end of Q4 to $65.74 at the end of Q1, a loss of $22.18 or 25.22% over the three months. SBUX hit an all-time high of $99.72 per share in July 2019. One of the many victims of Coronavirus was the bull market in stocks that lasted from 2009 through February 2020.
Coffee Outlook for Q2 2020
Coffee is a highly volatile agricultural commodity. The demand side of the fundamental equation in the coffee market was compelling based on the ever-increasing addressable market. The price pressure had come from a glut of supplies and a weakening currency in the world’s leading producer of Arabica beans, Brazil, which fostered a continuation of production. However, prices below 90 cents per pound proved unsustainable despite the weak level of the Brazilian currency.
As the quarterly chart highlights, coffee futures had been making higher lows since 2001 when the price hit lows of 41.5 cents per pound. In Q3 2018, the price action negated the pattern of higher lows as the price traded below $1 per pound for the first time since 2006. The low at 92 cents was the lowest since 2005. In Q2 2019, the bottom at 86.35 cents was the lowest since July 2005 when the price reached a bottom at 84.45 cents per pound. In Q3, the price remained above the Q2 low. In Q4, it took off on the upside. In a volatile market like coffee, the risk rises with the price of the soft commodity. In Q1, coffee made a higher low at 97.40 cents.
Meanwhile, coffee traded at over $2 per pound in 2014, and above the $3 level in 2011, 1997, and 1977. Weather and annual supplies of coffee beans is the chief determinant of the path of least resistance for the price of the soft commodity. Coffee inventories can provide a challenge each year as the commodity rots and deteriorate over time. Therefore, with the fickle nature of weather and production each year, the potential for upside gains from the current price level is compelling while increasing global demand should limit the downside. The price of coffee did nothing but make lower highs and lower lows from November 2016 through April 2019. However, the swift move to over the $1.40 level in December 2019 was a sign that coffee’s price momentum can turn on a dime. If the ICO is correct about supplies in the 2019/2020 crop year, much higher prices could be on the horizon for 2020. However, deflationary pressures on the back of Coronavirus and a plunging Brazilian real could not support a significant rally in the coffee market. The moderately bullish price action in the market that bucked the trend in almost all other markets was a testament to the strength in the Arabica coffee futures market.
The potential for production and logistical problems on the back of the most significant event to hit markets and challenge the world since the 1930s could cause wild price volatility in the coffee market in Q2 and beyond. At the same time, the global population continues to rise, expanding the demand side of the equation for the coffee market. The post-Coronavirus world will change, perhaps dramatically. Moreover, the global economy will limp or crawl out from the wake of the pandemic with massive deficits and financial fallout for years to come. We could see much higher levels of volatility in coffee and all market for an extended period, on the up and the downside.
The ICE futures and futures options market is the most direct route for a long position in the coffee market. However, the JO ETN product is an instrument that attempts to replicate the price action in the futures market. The coffee futures market has a long history of explosive volatility. While I am more bullish than bearish for the prospects for coffee futures going into the second quarter, I would only trade with very tight stops as wide price variance is likely to be the norm.
Cocoa was the best performer in the soft commodity sector in 2015. Cocoa was the only commodity that posted a double-digit gain in 2015 and won the gold medal for performance across all of the raw material markets that I cover. Cocoa was the worst-performing soft commodity and the worst-performing commodity of all in 2016, posting a loss of 33.79%, and the losing continued in 2017 with a decline of 11.01%. Cocoa moved 27.7% higher in 2018, making it the best-performing soft commodity of the year. Cocoa gained 5.13% higher in 2019. In Q1, cocoa traded in a wide range but fell 11.46%. As of the close of business on March 31, 2020, nearby ICE cocoa futures were trading at $2249 per ton. Cocoa futures traded in a range of $2183-$2998 per ton in Q1 and closed not far off the low.
The weekly chart of ICE cocoa futures illustrates that cocoa has made higher lows and higher highs with the most recent peak coming in mid-February during Q1. The Ivory Coast and Ghana have been working with the world’s leading chocolate manufacturers on a $400 per ton surcharge on cocoa beans from the West African nations. The theory behind the surcharge is to improve sustainability, guarantee farmers a premium for their beans, and reduce child labor in the cocoa business. Cocoa fell as risk-off conditions on the back of the Coronavirus sent the prices of most commodities lower. At the same time, weakness in the British pound, the pricing mechanism for many physical contracts weighed on the price of the soft commodity in March. Cocoa is historically sensitive to moves in the British pound as London is the hub of the physical cocoa market.
Cocoa traded to highs of $3,422 per ton in early December 2015 and then fell to lows of $1769 in June 2017. The midpoint of the trading range is $2,595.50 per ton. Cocoa closed Q1 below the average price since 2015. Open interest in ICE cocoa futures decreased from 281,569 contracts at the end of Q4 to 235,796 contracts at the end of Q1, a decline of 45,773 contracts, or 16.26% in Q1. Cocoa open interest reached a new record high at 365,293 contracts during Q1 on February 6 when cocoa as on its way to the new high at just under $3000 per ton.
Price momentum on the daily chart was in oversold territory at the end of Q1, while the weekly chart was below neutral territory and falling. The monthly chart crossed lower in the upper region of neutral territory. Cocoa fell from over $3400 per ton in December 2015 to lows of $1769 in June 2017. While cocoa closed Q1 on a weak note, the soft commodity made a new high during the first three months of 2020 and traded in a wide range.
The forward curve in the cocoa futures market was in a small contango from May 2020 through September 2020 and then moves into small backwardation from September 2020 out to December 2021, which is not a bearish sign for the price of the soft commodity. Over 60% of the world’s annual supplies come from West Africa, which can make output and logistics problematic at times because of the fickle nature of African politics. At the same time, since cocoa is the primary revenue-producing commodity in the Ivory Coast and Ghana, child labor in those countries poses a moral dilemma for chocolate manufacturing companies and western governments in the US and Europe. A move to stop the number of children involved in the production process could increase the price of the soft commodity via the surcharge. Meanwhile, as Coronavirus impacts Africa, it could cause production and logistical problems and curtail global supplies.
Cocoa Outlook for Q2 2020
Cocoa is another soft commodity where increasing demand underpins the price of the primary ingredient in chocolate confectionery products.
On the quarterly chart, price momentum was just below neutral territory at the end of Q1.
The Chinese have developed a taste for chocolate, and as most people will attest, once you taste the delicious treat, there is no turning back, which opens a vast addressable market for the demand for cocoa beans. The world’s major producers of cocoa beans are the West African nations of the Ivory Coast and Ghana. Between them, they are responsible for around 60% of the world’s production. The political stability of the two primary producing nations can always become an issue when it comes to production and the logistics of transporting cocoa beans to ports for exportation around the world.
Meanwhile, the global pandemic could eventually support prices for two reasons. A labor shortage could weigh on supplies, and the flood of stimulus into markets that depress currency values could eventually cause the prices of all commodities to rise. We should expect lots of volatility in all markets over the coming months, and cocoa is no exception. Meanwhile, the weather conditions in the critical growing regions of the world always have the potential to cause supply problems if crops are not sufficient to satisfy global requirements.
Technical support for cocoa futures is at $2089 per ton. Resistance is at the Q1 2020 peak at $2998 per ton as we move into Q2. From a shorter-term perspective, the mid-March low at $2183 is a support level, and $2644, the March 11 high, is the first level of resistance.
The NIB ETN product does a reasonable job replicating the price action in the ICE cocoa futures market, which is the best route for direct investment in the price of the primary ingredient in chocolate other than the futures arena. Any supply issues in West Africa could cause surprises in this soft commodity. In 2002, I am cautiously bullish for the prospects of cocoa futures and the NIB ETN product as the market has made a series of higher lows since late 2017. Buying cocoa on dips and taking profits at higher highs has been the optimal approach to the futures market and the NIB ETN product since late 2018. However, we could see wide price variance on the back of the global pandemic in Q2, which could defy technical and fundamental analysis.
Cotton was the worst-performing soft commodity in 2014; it moved 27.33% lower for the year. In 2015, the price of cotton appreciated by 4.99%, and in 2016, cotton gained 11.65%. Cotton moved 11.3% higher in 2017. Nearby ICE cotton futures moved 8.18% lower in 2018. In 2019, the price of cotton moved 4.36% lower. Cotton was the worst-performing soft commodity in Q1 as the price fell 25.95%.
As the weekly chart highlights, in Q1, cotton futures fell to a new low of 48.40 cents per pound, the lowest price since 2009. Nearby ICE cotton futures settled on March 31, 2020, at 51.13 cents per pound, not far off the low.
Cotton is a highly volatile commodity, and in March 2011, cotton traded up to an all-time high of $2.27 per pound on supply shortages. Following the all-time high, the price moved progressively lower until finding a low at 55.66 cents in March 2016. In Q1 2020, the risk-off conditions on the back of Coronavirus took the price below the 2016 low and to a level not seen in eleven years.
The USDA said:
“This month’s 2019/20 U.S. cotton forecasts show lower production, price, and ending stocks relative to last month. Production is reduced 300,000 bales to 19.8 million, based on the March 10 Cotton Ginnings report. The final estimates for this season’s U.S. area, yield, and production will be published in the May 2020 Crop Production report. Domestic mill use and exports are unchanged from last month, and ending stocks are lowered 300,000 bales to 5.1 million. The projected marketing year average price received by upland producers of 60.0 cents per pound is down 2 cents from last month. The global cotton supply and demand estimates show larger production and ending stocks. Consumption is forecast 850,000 bales lower, as a 1-million-bale cut in China’s expected consumption is only partially offset by increases for Bangladesh and Turkey. Production is up about 250,000 bales as larger expected crops in Brazil, Chad, and Tajikistan offset a lower U.S. crop and some smaller declines elsewhere. Ending stocks for 2019/20 are projected 1.3 million bales higher this month and 3.2 million bales higher than in 2018/19.”
Source: USDA March WASDE report
Rising global stocks during a deflationary spiral sent the price of the fiber lower. The trade war between the US and China weighed on the price of cotton in 2018 and 2019 at times, but the events in Q1 sent the price of the fiber below the 50 cents per pound level.
As the forward curve demonstrates, term structure in cotton futures is in contango from July 2020 through May 2021 when the curve flattens out to December 2022. There was a small backwardation in cotton from the nearby May delivery month to the July contract.
China and India are significant factors for the cotton market due to their domination when it comes to supply and demand for the fiber. Meanwhile, economic contraction could weigh on the demand for garments. Coronavirus sent the price lower but could also set the stage for a future supply shortage if producers cut back on production.
Open interest in the fiber moved lower from 222,851 at the end of Q4 2019 to 194,311 at the end of Q1, a decline of 28,540 contracts, or 12.81% in Q1. Falling open interest and fall price is not typically a validation of a bearish trend in a futures market, but the events of Q1 were anything but typical. The metric hit a new all-time high in early June 2018 when it rose to 322,153 contracts.
The daily chart of May cotton futures highlights that cotton reached a high of 73.08 per pound on January 13 and made lower highs and lower lows throughout the rest of the quarter. The high came in anticipation of the signing of the “phase one” trade deal between the US and China. However, the outbreak of the virus in Wuhan and its spread around the world weighed on the price of the fiber futures. Technical resistance and support levels are at just over 73 cents and the recent low at below 50 cents per pound. The state of the global economy and the weather conditions in growing regions in the second quarter will be the critical factors when it comes to the price direction of cotton futures on the Intercontinental Exchange. However, the stop in business activity in Q1 is likely to cause inventories to rise and the price of the fiber to continue to drift lower until it finds the bottom end of its pricing cycle.
Cotton Outlook for Q2 2020
Cotton had been making upside progress since hitting bottom at 55.66 cents per pound in March 2016. In 2016, the price recovered to a high of 77.80 cents. In 2017, the high was at 87.18 cents per pound. In 2018, the price reached a high of 96.50 cents.
As the quarterly chart highlights, cotton has been making higher lows since 2001 when the price traded to lows of 28.20 cents per pound. In 2011, a shortage took the price to highs of $2.27, but since correcting to 55.66 cents, the fiber had been making higher lows and higher highs. In Q1 2020, cotton fell below the 2016 low. Moreover, the close below the Q4 2019 bottom at 59.90 caused a bearish key reversal trading pattern on the quarterly chart, which puts long-term technical support at the 2008 low of 36.70 cents per pound.
Cotton is a highly volatile commodity on the futures market and, at times, suffers from a lack of liquidity during significant price moves. We could see wide price variance in Q2. While economic contraction in the face of the global pandemic is bearish for all asset prices, falling production on the back of the lowest prices in years could provide fundamental support. As inventories decline, the volatile cotton market could make a move to the upside. At the same time, the massive stimulus programs and a flood of liquidity could eventually cause inflationary pressures that would support the price of cotton and most other raw materials. I expect lots of price volatility for the foreseeable future. Cotton suffers from periods of illiquidity, which could cause price gaps on the up and the downside during these uncertain times.
BAL is the cotton ETN product that suffers from limited liquidity. The average volume of the ETN declined in Q1. The average trading volume moved from 4,265 shares as of the end of Q4 to 3,130 contracts at the end of Q1, likely because of risk-off conditions. The cotton futures and futures options market on ICE is the direct route for trading the fiber. Cotton is a market that can be wild at times and is not for the faint of heart as it requires market participants to take lots of risks. The price of cotton can move significantly on a percentage basis, so the potential for rewards balances the risks in the fluffy fiber futures. At around fifty cents per pound, the odds favor the upside. However, the potential for a recovery in the cotton market is likely in the hands of scientists working on treatments and a vaccine for Coronavirus. The trend at the end of Q1 remained lower.
Frozen Concentrated Orange Juice Review
Trading FCOJ futures is a frantic business; I would not recommend it to anyone because of the lack of liquidity. The orange juice futures market edged lower in Q4 2019. FCOJ was virtually unchanged in 2015, falling by only 0.04%. In 2016, FCOJ gained 41.50%, making it the best performing soft commodity. FCOJ moved 31.35% lower in 2017. FCOJ futures fell 7.98% in 2018. The soft commodity was 22.33% lower in 2019, making it the worst-performing soft commodity for the quarter and year. As often occurs, the worst performance during one period becomes the best the next. In Q1 2020, FCOJ futures posted a 23.66% gain making it the leader of the soft commodity sector and when compared to all of the other futures markets in the asset class. Orange juice traded in a range of $0.9120 to a high of $1.2255 per pound in Q1. FCOJ settled on March 31, 2020, at $1.2020 per pound.
As the weekly chart highlights, FCOJ futures had made lower highs and lower lows since June 2018. Brazil is the world’s leading orange producing nation. The lower level of the Brazilian currency, the real, weighed on the price of FCOJ in 2018 and 2019. At the end of Q1 2020, FCOJ broke out to the upside after trading in a consolidation pattern since May 2019. Over the past 40-plus years, FCOJ futures had traded as low as 37.4 cents and as high as $2.35 per pound. In Q4 of 2016, OJ rose to the highest level in history. Most recently, the FCOJ price rose to over the $1.70 level because of a shortage of oranges from Brazil, the world’s leading producer of the citrus fruit in May 2018, but the price traded around the $1 per pound level May 2019 through March 2020 when it broke out to the upside at the end of Q1. Open interest decreased from 17,058 at the end of Q4 to 13,085 at the end of Q1 2020, a drop of 23.3%. The metric rose to a record high at 22,360 contracts on February 19, 2019, as the price of the soft commodity was falling towards the low for the year. The metric tends to move higher at highs and lows and before significant price moves in the futures market for FCOJ. Open interest dropped sharply during the risk-off period caused by the global pandemic.
The forward curve in the FCOJ futures market is steady contango from May 2020 out to January 2023, which is a sign of more production in the coming months and years.
OJ is a thin and illiquid market that is dangerous as it is susceptible to price gaps when the price is moving. The price below the $1 per pound level became unsustainable.
FCOJ Outlook for Q2 2020
Just like in many other agricultural commodities futures market, the price of FCOJ futures has been making higher lows for more than a decade.
As the quarterly chart illustrates, the floor price for FCOJ futures has been moving higher since 2004 when it traded at 54.20 cents per pound. At the same time, the market has been making higher highs, with the most recent new high coming in November 2016 at $2.35 per pound. FCOJ futures were in the buy-zone at below the $1 level, but the volatile futures can be dangerous given the limited liquidity during price moves. The global pandemic could create problems in the supply chain when it comes to Brazil, which likely caused the price to break out of its trading range to the upside at the end of Q1.
Unfortunately, there are no ETF or ETN products in the FCOJ market. The only route for trading is via the ICE futures contract. The average daily volume tends to be well below 1,000 contracts. At the end of March, the volume in the futures market increased substantially as the price rose, which is a bullish sign in a futures market.
The bottom line and a quick look at lumber
Four of the five soft commodity prices moved lower in Q1. FCOJ was the star performer, but it rallied without the help of the Brazilian currency. However, supply chain issues in Brazil could have prompted the price appreciation. Cotton was the worst-performing soft commodity as the price dropped to the lowest level since 2009 on the back of the outbreak of Coronavirus. Sugar and cocoa also posted double-digit percentage losses, while coffee also fell. The weak Brazilian real was not a supportive factor for coffee and sugar prices.
The potential for supply issues is always a danger when it comes to these agricultural commodities markets. The global economic meltdown in Q1 could cause supply chain problems as well as production issues when it comes to labor in producing nations. We are likely to see continued price volatility in all markets in Q2, and soft commodities are no exception.
The trade issues from 2018 and 2019 calmed after the US and China signed a “phase one” trade agreement on January 15. However, the spread of Coronavirus quickly became a far more serious event when it comes to the global economy. Over the coming weeks and months, the world will continue to make every effort to contain the spread of the virus and stabilize economic conditions, while scientists work furiously to find treatments and develop a vaccine. Science moves a lot slower than both the spread of COVID-19 and the price action in markets. Four of the soft commodities feed the world, while one provides clothing, bedding, and medical and other supplies. Expect lots of volatility as the weather, the global supply chain, and a host of other factors could cause increased price variance during the second quarter of 2020.
The lumber market posted a significant double-digit percentage loss in Q1, as the price put in a bearish reversal on the quarterly chart on the back of the global pandemic. In mid-May 2018, lumber futures traded to a new all-time high when the price reached $659.00 per 1,000 board feet surpassing the February peak at $536.20 and the 1993 previous record high at $493.50.
The long-term quarterly chart shows that lumber had been moving higher since September 2015 when the price found a bottom at $214.40 per 1,000 board feet. Lumber had been making higher lows since 2009 when the price trade to $137.90. The wood market gained 28.72% in 2016 and did even better in 2017, rising by 36%. After reaching a record high at $659 per 1,000 board feet in May 2018, the lumber market plunged and finished 2018 with a 25.78% year-on-year loss. In 2019 lumber moved 21.89%. In Q1 2020, the price fell 31.29%. The price of nearby lumber futures closed on March 31, 2020, at $278.50 per 1,000 board feet. In Q1, lumber traded in a wide range from $278.50 to $477.70 per 1,000 board feet and closed at the end of March at the low of its trading band for the year, which points to further declines.
Lower interest rates in the US typically increase the demand for new home construction, which translates into more demand for wood, which is a critical industrial commodity. However, rates have dropped to historic lows, and the deflationary spiral has weighed on the need for and price of lumber.
Total open interest in the lumber market was at 2,824 contracts, which is 453 contracts lower from the Q4 2019 closing level as of the end of the first quarter of 2020. Lumber futures tend to trade less than 1,000 contracts each day. A day where more than 1,000 contracts change hands often occurs when a significant trend is underway. Daily volume had been below the 500 level throughout most of the latter part of March.
Lumber is not a liquid market, and I would discourage anyone from trading in this market. However, lumber is a vital benchmark commodity, and it behooves all investors to monitor the price action as it provides clues about economic conditions and demand for industrial raw materials.
New home and infrastructure building would provide for the lumber market, but the deflationary environment and shutdown of many parts of the US and global economies continued to weigh on the price of wood at the start of Q2 2020.
WOOD and CUT are top lumber products that trade on the stock exchange. WY is a company that operates as a real estate investment trust in the lumber market with properties in the US and Canada. WOOD, CUT, and WY shares tend to move higher and lower with the price of lumber. The prices of these instruments fell sharply with the price of wood and the stock market in Q1. In Q2, the potential for rebounds depends on the progress towards treatments and a vaccine for COVID-19, as well as a return of construction activity.
Soft commodities prices are some of the most volatile in all of the sectors of the raw materials asset class. These commodities tend to move to the top and bottom ends of their pricing cycles often, and the weather conditions around the world, along with crop diseases and acts of nature can wipe out annual crops in the blink of an eye at times. The virus presents another set of challenges for the agricultural products from production to the supply chain.
The Invesco DB Agriculture product (DBA) includes an almost 19% exposure to the three most active soft commodities as it holds positions in sugar, coffee, and cocoa futures contracts. The fund summary for DBA states:
“The investment seeks to track changes, whether positive or negative, in the level of the DBIQ Diversified Agriculture Index Excess Return™ (the “index”) over time, plus the excess, if any, of the sum of the fund’s Treasury Income, Money Market Income and T-Bill ETF Income, over the expenses of the fund. The index, which is comprised of one or more underlying commodities (“index commodities”), is intended to reflect the agricultural sector. The fund pursues its investment objective by investing in a portfolio of exchange-traded futures.”
The most recent top holdings of DBA include:
The soft commodities sector posted an 8.78% loss in Q1 2020.
As the chart of DBA illustrates, it moved from $16.56 at the end of Q4 to $14.07 at the end of Q1 2020, a decline of $2.49 or 15.04%. Declines in some of the other agricultural commodities weighed on the performance of DBA in Q1. Moreover, the cost of rolling futures contracts in contango markets is a cost that the ETF product passes on to holders.
The one constant in all of these agricultural commodities is that the growing world population continues to underpin prices. As demand rises each year, the world depends on growing supplies. In years where production is abundant, prices do not feel the impact of the rising demand. However, when shortages develop, price action can become explosive. The global pandemic will present new challenges for many members of the sector. Soft commodities can be one of the most volatile sectors of the commodities market, and the price variance often occurs when market participants least expect price moves. Q2 2020 and beyond has the potential to be a volatile time for this sector of the commodities market where prices routinely double, triple, and halve in value because of weather, crop disease, currency moves, and other exogenous factors, such as the current unprecedented environment that impacts all people around the globe.
Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.