Summary

  • The soft commodities sector posts a 2.82% loss in Q2.
  • Coffee and cocoa lead the pack with 14.55% and 7.46% respective gains
  • Cotton and OJ posted double-digit percentage losses of 18.63% and 15.8% respectively
  • Sugar edges 1.68% to the downside
  • The Brazilian real edges 1.6% higher which is supportive of sugar, coffee, and orange prices

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 between 18-20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by over 26.3%, which amounts to over 1.58 billion people. More people with more money consumes more coffee, cocoa, sugar, cotton, and orange juice each day, which underpins the prices of these commodities.

The composite of five soft commodities sugar, coffee, cocoa, cotton, and frozen concentrated orange 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 Q1, the soft commodities composite declined by 1.08%, and Q2 the sector slipped by another 2.82%, making the total loss over the first six months of 2019 4.35%.

The dollar index moved 1.22% lower in Q2, but only 0.07% to the downside over the first half of the year after moving 4.26% higher in 2018. The dollar moved considerably higher against the Brazilian real in 2018, and the real remained weak in Q1 with other emerging market currencies. However, the Brazilian currency gained back around 1.6% in Q2. Brazil is the world’s leading producer of three of the five commodities in the sector, including sugar, coffee, and oranges. 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 Q3, 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.

While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes just under a 17% 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 did not move all that much in Q2, but some of the individual markets displayed a high degree of price variance throughout the quarter that ended on June 28.

Sugar Review

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. Sugar traded in a range of 11.36 to 13.96 cents over the first six months of 2019. 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 as the nearby ICE futures contract was expiring. Nearby sugar futures that trade on the ICE settled on June 28, 2019, at 12.32 cents per pound as it moved 1.68% lower in Q2 and was 2.41% higher over the first half of 2019.

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, throughout 2018 and into 2019 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. However, the level of the real has stabilized over the recent months, and the price of ethanol rose in Q2 which could turn out to be a supportive factor for the price of sugar as Brazil processes sugarcane into the biofuel. Ethanol fell to a new record low at under $1.20 per gallon in Q4 2019. Ethanol appreciated in Q1, and the price exploded by 11.9% in Q2 on the back of higher corn prices in the US. While Brazil processes sugar into ethanol, the US refines corn into the biofuel. The level of the real against the dollar rose marginally from $0.2570 against the US dollar at the end of Q1 to $0.256110. At the same time, crude oil fell from $60.14 per barrel at the end of Q1 to the $58.47 level at the end of Q2 which was not a bullish factor for the price of sugar since it is the primary ingredient in the production of the alternative fuel in Brazil.

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 in 2018, falling from 0.32 to under the 0.24 level, which put additional pressure on the sugar price. However, the bounce in the real in Q4 was one of the reasons that sugar recovered Q4. The real edged was stable in Q2, and so was the price of sugar which posted a small loss for the quarter.

Source: CQG

As the weekly chart of the Brazilian currency against the dollar shows, the real plunged from 0.32 against the dollar in late January of this year to a low of 0.23625 in Q3. 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. In Q4, the real recovered to a high at 0.28035 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. The real ran into selling at the highs as the market is now waiting to see if the new leader follows through on his promises from the campaign trail. The real declined from a lower high at $0.27475 in early Q1 which helped to push the price of nearby ICE sugar futures to around the 12.50-cents per pound level. The price of sugar has been static around that level.

Sugar production from India and Brazil, a falling Brazilian real, and increased output from other producing nations had created a perfect bearish storm for the sweet commodity throughout much of 2018. However, prices fell to a level that turned out to be unsustainable on the downside below the 10 cents per pound level in Q3 2018, leading to the recovery in Q4. In Q2 the price of sugar continued to consolidate in the 11.36 to 13.96 range, and it closed on June 28 within its trading band.

The sugar market was in a backwardation, where deferred prices moved lower than nearby prices which is a sign of tight supplies during the rally that ended in late 2016, but the lower price has led to a return to contango, or higher deferred prices in the forward curve.

Source: ICE

The forward curve in sugar futures highlights the steady contango out to the first half of 2022, which is a sign of sufficient supplies. The forward curve offers clues about the balance between supply and demand. The prices out to 2022 indicate plentiful supplies, but sugar cane for delivery later in 2019 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.

Source: CQG

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 Q2 2019, that number stands at over 7.58 billion, an increase of over 56% over the past thirty-four years. The number of people on our planet has increased exponentially over the past three decades, which has increased demand for all agricultural commodities, and sugar is no exception. The quarterly chart remains in a downward sloping trend when it comes to price momentum but is in oversold territory.

Source: CQG

The monthly chart shows that price momentum is in neutral territory. The rising ethanol price is a supportive factor for the price of sugar prices.

Source: CQG

As the weekly chart illustrates, price momentum crossed to the downside in overbought territory as the price turned lower from the 14.24 high in late October and is now in the lower section of overbought territory.

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. However, the weak Brazilian currency and increased Indian subsidies helped sugar move lower in 2018. 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 lead to its recovery. Sugar continued to consolidate in Q2 which could be a healthy sign for the market going forward.

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. The Indian subsidies had created an environment where a government-sponsored glut of sugar was flooding the world market and weighing on the price, which is an unsustainable situation over the long-term. When government-subsidized products flood international markets, they damage economic conditions in other nations where governments do not provide aid to producers. The current trade issues between the U.S. and trading partners around the world are an attempt to address this situation and create a level playing field where the most efficient producers can sell to the consumers willing to pay the most. The most significant issue when it comes to trade is the dumping or selling subsidized products in markets that make domestic output or manufactured products uncompetitive.

Open interest stood at 906,980 contracts at the end of Q1 and declined to 865,373 contracts at the end of Q2, a drop of 41,607 contracts or 4.59% over the past three months. The metric rose to over 1.061 million contracts in August 2018, which was an all-time high. It is likely that speculative trend-following shorts helped sugar drop to a decade low at 9.83 cents in 2018.

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 25.87%, which was 9.8% higher than it was on the final day of trading in Q1 2019 As we move forward into the second half of 2019, technical support for sugar stands at 9.83 cents and 9.44 cents per pound with resistance at 14.24 and 15.49 cents per pound.

Sugar Outlook for Q3 2019

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.

Looking forward to the third quarter and second half of 2019, nothing much has changed in the sugar market since the end of Q1. The current consolidation is a healthy sign for the sugar market. However, the price of ethanol in Brazil and the level of the Brazilian real are primary factors when it comes to the direction of the price of sugar over the coming three months. I believe that the downside is limited, and upside could become interesting if the weather conditions interfere with production.

The levels of technical support stand at last year’s low at 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. While the supply side of the fundamental equation continues to weigh on the price of sugar, the demand side has increased dramatically over the past decade. A population increase of 18-20 million people per quarter means that there are now over three-quarters of a billion more mouths to feed in the world than the last time sugar traded at its current price level. I am modestly bullish on the prospects for the sweet commodity going into the third quarter. I will be keeping a close eye on the Brazilian real over the coming weeks and months for clues about the price direction of the sugar futures market.

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. When I buy sugar, 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.

I will continue to be a cautious buyer on price weakness and seller on rallies to take profits as I will approach sugar from the long side of the market. As the new leader of Brazil makes reforms, we could see the Brazilian currency move higher against the dollar, which would support gains in the price of sugar. However, that has yet to materialize. At the same time, the ever-expanding addressable market for sugar and the always-present danger of a weather-related issue could cause lots of volatility over the coming year. At around 12.32 cents per pound, I continue to prefer to trade sugar from the long side of the market.

Coffee Review

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 Q1, the selling continued, and coffee posted a 7.22% loss. However, in Q2, coffee futures posted a 14.55% gain and were 6.28% higher over the first six months of 2019. Nearby ICE coffee futures closed on June 28, 2019, at $1.0825 per pound. The price range over the first half of this year was from $0.8635 on the lows to $1.1565 on the highs. Coffee fell to a lower low than the 2018 bottom in Q2, but the price recovered. Coffee has been making lower highs and lower lows since November 2016 when the price peaked at $1.7600 per pound.

Source: CQG

The weekly chart highlights that coffee futures have 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. Meanwhile, price momentum on the weekly chart was rising in overbought territory at the end of Q2.

Source: CQG

The daily chart of the active month May ICE coffee futures contract illustrates that price momentum was rising towards an overbought condition.

Source: CQG

Meanwhile, the monthly chart displays a market at the upper end of an oversold condition with technical support now at the recent low at 86.35 cents and the September 2005 bottom at $0.8445 per pound. Open interest had been trending higher with the bearish price action, which is a technical validation of the downward trend in the coffee futures market. However, the metric corrected in Q2.

Open interest in coffee futures moved significantly lower over the past three months. Open interest stood at 355,289 at the end Q1 and fell to 266,452 at the end Q2 a decline of 79,195 contracts or 25% over the second quarter of 2019. Open interest rose to a new record high in Q1 of this year. The metric declined as the July futures rolled to September.

Source: ICE

Coffee futures were in steep contango at the end of Q2, a sign of oversupply in the coffee market.

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. Strength in the stock market combined with the benefit of a lower price for coffee over the past three months pushed both share prices higher in Q2.

Source: Barchart

As the chart shows, DNKN stock moved from $75.10 per share at the end of Q1 to $79.66 and the end of Q2, an increase of 6.1% over the three-month period. DNKN shares moved to a high at $83.22 on June 22.

Shares of SBUX also moved higher in Q2.

Source: Barchart

As the chart shows, SBUX shares moved higher from $74.34 at the end of Q1 to $83.83 at the end of Q2, a gain of $9.49 or 12.8% over the three-month period. The lower price of coffee and strong stock market combined to push the prices of DNKN and SBUX higher over Q2 and the first half of 2019.

Coffee Outlook for Q3 2019

Coffee is a highly volatile agricultural commodity. The demand side of the fundamental equation in the coffee market is compelling based on the ever-increasing addressable market. However, the price pressure has 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. While coffee recovered to $1.2550 per pound in mid-October, the price fell back to a new and lower low on the nearby ICE futures contract in Q2 in a sign of continued weakness for the soft commodity.

Source: Barchart

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. However, in Q3, 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, the bottom at 86.35 cents was the lowest since July 2005 when the price reached a bottom at 84.45 cents per pound. At just over $1 per pound level, there is always a chance that the price could once again head for the recent low. The next level of technical support on the long-term chart is at the 2005 low at 84.45 cents and then at the Q4 October 2001 low at 41.50 cents per pound, more than half the current price level. Coffee recovered, and I continue to believe that the price offers value at anywhere under the $1 per pound level.

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 had done nothing but make lower highs and lower lows since November 2016. However, the swift move to $1.2550 in October was a sign that coffee’s price momentum can turn on a dime. I continue to favor long positions in coffee, going into Q3.

The potential for coffee is a compelling story as it remains near the bottom of its pricing cycle. A rebound in the Brazilian real would likely send the price of the soft commodity higher. 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. Coffee had been more than a frustrating market from the long side over 2018, but at the current price, production and inventories could begin to decline as demand is steadily rising. The frustration continued in Q2, but the price recovered at the end of the quarter after the July-September futures roll period. A weather event, rising Brazilian real, or the power of increasing demand will eventually cause the price of coffee to find a bottom and turn higher in a sustained move. The coffee futures market has a long history of explosive volatility. At the current price, I continue to believe the risk-reward of a long position in coffee continues to favor the upside.

Cocoa Review

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. In Q1, cocoa corrected lower by 5.63%. In Q2, the price gained 7.46% as cocoa was 1.41% higher over the first six months of 2019. As of the close of business on June 28, 2019, nearby ICE cocoa futures were trading at $2450 per ton. Cocoa futures traded in a range of $1901-$2583 per ton over the first six months of this year. The lows so far this year at $1901 was a one-day event during the roll from March to May futures. Otherwise, cocoa traded above the $2100 per ton level in 2019.

Source: CQG

The weekly chart of ICE cocoa futures illustrates the significant price recovery that took the soft commodity to highs of $2914 per ton in late April and early May 2018. Since then, the price of cocoa had been in a range from $2000 to $2400 per ton, aside from the one-day violation on the downside. Meanwhile, cocoa took off on the upside after the spike to the lows and reached a peak at $2583 per ton in mid-June. The cocoa grind data in April was bullish for the price as were reports that production from Ghana was below prior expectations, which provided support for the price of the primary ingredient in chocolate.

Cocoa traded to highs of $3,422 per ton in early December 2015 and then fell to lows of $1769 in June 2017. A 50% retracement of the move from the highs to lows, was at $2,595.50 per ton. In mid-March 2018, cocoa reached and exceeded that level, and it kept on going reaching a peak of over $2900 per ton. However, the primary ingredient in chocolate confectionery products left a gap on the weekly chart from $2320 to $2430 per ton, which acted as a magnet for the price in Q2 last year. That $2900 level continues to stand as critical technical resistance in the cocoa futures market.

Cocoa was historically sensitive to moves in the British pound as London is the hub of the physical cocoa market. However, the problems surrounding Brexit appears to have changed that relationship.

Open interest in ICE cocoa futures increased from 260,044 contracts at the end of Q1 to 263,024 contracts at the end of Q2, a rise of 2,980 contracts or 1.15% over the past three months. Cocoa open interest reached a new record high at 310,808 in Q3 last year on May 31, 2018. Price momentum on the daily chart is falling in neutral territory after the recent high, while the weekly chart is in overbought territory and crossing lower, and the monthly chart crossed higher and is heading for overbought territory. Cocoa fell from over $3400 per ton in December 2015 to lows of $1769 in June 2017. It then recovered to a high of $2914 one year later and is now trading at the $2450 per ton level as we move into Q3.

Source: ICE

The forward curve in the cocoa futures market was in a small backwardation out to September 2019 and then is relatively flat out to May 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.

Cocoa Outlook for Q3 2019

Cocoa is another soft commodity where increasing demand underpins the price of the primary ingredient in chocolate confectionery products.

Source: CQG

On the quarterly chart, price momentum is rising gently towards neutral territory at the end of Q2.

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. At the same time, grind data from Asia have been rising to new record highs, which is supportive of the price of cocoa beans.

Technical support for cocoa futures is at $1982 per ton as I am ignoring the one day move to $1901 as an anomaly. Resistance at the 2018 peak at $2914 per ton as we move into Q3. From a shorter-term perspective, the mid-June high at $2583 is a resistance level, and $2000 on the downside is a critical psychological level for the cocoa futures market.

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. For the coming quarter, 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, and that is likely to continue.

Cotton Review

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 Q1, the price of cotton posted a 7.49% gain, but in Q2 it fell by 18.63% and was 12.53% lower over the first six months of 2019. Cotton was the worst-performer in the soft commodities sector in Q2.

Source: CQG

As the weekly chart highlights, in Q2 cotton futures fell to a low at 60.27 cents during the recent July roll period. On the active month futures contract, cotton traded in a range from 60.27 cents to 79.57 cents so far in 2019, and the price closed near the highs for the quarter. Nearby ICE cotton futures settled on June 28, 2019, at 63.15 cents per pound.

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. As the weekly chart highlights, the fluffy fiber futures had been rising since October 2017, making higher lows and higher highs. However, in Q2, the price dropped below the 70 cents per pound level and to just above 60 cents, the lowest price of 2019 and since May 2016. In the June WASDE report, the USDA told the cotton market that US supply and demand estimates were unchanged from Q1, but beginning global stocks rose because of higher production from India and lower consumption in

China. The USDA said:

The 2019/20 U.S. cotton supply and demand projections are unchanged from last month, with the exception of a 1-cent decline in the season-average upland farm price, to 64 cents per pound. The 2018/19 U.S. cotton balance sheet is unchanged. The world 2019/20 cotton projections include higher beginning stocks, slightly lower production, lower consumption and trade, and higher ending stocks. Ending stocks for 2019/20 are projected 1.6 million bales higher than in May, due to a 1.1-million-bale increase in beginning stocks and a 660,000-bale decline in consumption. Beginning stocks are higher largely due to larger 2018/19 production in India and lower 2018/19 consumption in China. World consumption and imports in 2019/20 are projected lower largely due to a 500,000-bale decline in each variable’s forecast for China. Lower exports are expected for Australia due to lower production, but higher expected exports from India are partly offsetting.

Source: USDA

Meanwhile, the trade issues between the United States and China had weighed on the price of cotton, and the June 29 summit between Presidents Trump and Xi is likely to impact the path of least resistance for the price of cotton futures in Q3. Tariffs and retaliation distort prices and could interfere with the flow of cotton from U.S. producers to Chinese consumers. Tariffs and subsidies interfere with price dynamics as they distort supply and demand fundamentals. A trade deal between the two nations would likely be bullish news for the price of cotton in Q3. A continuation of an escalation of protectionist policies would not be a supportive factor for the price of the fiber.

 

Source: ICE/RMB

As the forward curve demonstrates, term structure in cotton futures is in contango from July 2019 through July 2020 and then flattens out past next July.

China and India are significant factors for the cotton market due to their domination when it comes to supply and demand for the fiber, but the weaker dollar in Q2 did not support the price of the fiber as trade trumped the greenback. Meanwhile, economic growth around the world will determine the demand for garments. The trade dispute with China could be the most significant issue facing the cotton market in Q3, given its impact on the Chinese and global economic conditions.

Open interest in the fiber moved lower from 225,886 at the end of Q1 to 175,945 at the end of Q2 a decline of 49,941 contracts or 22.1% in Q2. Falling price and dropping open interest are typically not a validation of a bearish trend in a futures market. The metric hit a new all-time high in early June 2018 when it rose to 322,153 contracts.

Source: CQG

The daily chart of December cotton futures highlights that cotton has settled into a trading range between 64.70 and 68.60 since mid-May as the contango in the cotton market makes the price of December cotton higher than the expiring July contract that fell to just over the 60 cents per pound level. Technical resistance and support levels are at the top and bottom ends of the range which mid-May. On the longer-term charts, 60 cents is the support level, and 70 cents per pound is the first critical level on the upside. Trade issues between the US and China and the 2019 crop will be the most significant issues facing the cotton market in Q3. In Q2, cotton dropped in mid-May which coincided with the escalation of the trade dispute.

Cotton Outlook for Q3 2019

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 at 96.50 cents.

Source: CQG

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. However, in Q2, the nearby cotton futures contract put in a bearish reversal on the quarterly chart which suggests that the price could be on its way to a test at below the 60 cents level. Meanwhile, trade will likely trump the technical pattern in the market if there is progress on trade. If not, the price reversal in Q2 could lead to more selling in Q3.

Cotton is a highly volatile commodity on the futures market and at times, suffers from a lack of liquidity during significant price moves. The results of trade negotiations with China are likely to make or break the price of the fiber in Q3.

BAL is the cotton ETN product, while it continues to build critical mass, the new instrument continues to suffer from a significant lack of liquidity with an average trading volume of only 2,112 shares as of the end of Q2. 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. However, the price of cotton can move significantly on a percentage basis, so the potential for rewards balances the risks in the fluffy fiber futures.

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 had a rough time in Q2 and was the second worst-performing soft commodity over the period. 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. In Q1, the bearish price action took the price of OJ 4.2% lower for the quarter. In Q2, the price fell by 15.8%, OJ moved 19.34% lower over the first six months of 2019. Orange juice traded in a range of $0.9030 to a high of $1.3135 per pound over the first half of 2019, and settled on June 28, 2019, at $1.0095 per pound. FCOJ fell to its lowest price since 2009 in Q2.

 

Source: CQG

As the weekly chart highlights, FCOJ futures have 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 in 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, but the price moved lower from Q4 2018 through Q2 2019. The price of FCOJ futures tends to be highly sensitive to weather conditions in Florida over the winter season as freezes can cause significant rallies in the futures market. Over the recent winter, the price of the commodity slumped. Open interest decreased slightly from 19,504 at the end of Q1 to 19,259 at the end of Q2, a decline of 245 contracts. The metric rose to a record high at 22,360 contracts on February 19 as the price of the soft commodity was falling towards the low for the quarter. The metric tends to move higher at highs and lows and before significant price moves in the futures market for FCOJ.

Source: ICE/RMB

The forward curve in the FCOJ futures market is in a steady contango out to May 2022, which is a sign of ample supplies.

OJ is a thin and illiquid market that is dangerous as it is susceptible to price gaps when the price is moving. However, at the $1 per pound level, FCOJ futures are at a level from where they bounced higher and recovered over the past decade.

FCOJ Outlook for Q3 2019

Just like in many other agricultural commodities futures market, the price of FCOJ futures has been making higher lows for more than a decade.

Source: CQG

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 coming in November 2016 at $2.35 per pound. FCOJ futures are likely in the buy-zone at the $1 level, bit the volatile futures can be dangerous given the limited liquidity during price moves.

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 below 1,000 contracts, but the volume had been increasing over the past three months. I will be looking for open interest to decline and volume to dry up as a sign that a reversal to the upside is on the horizon over the coming days and weeks. A drop in the metrics could be a sign that the selling that plagued the market since mid-2018 is drying up. Volume and open interest tend to begin to increase once a trend gets underway.

The bottom line and a quick look at lumber

Two of the five soft commodity prices moved higher in Q2. Coffee remains near the bottom end of its pricing cycle while sugar has been consolidating, and cocoa had been making upside progress in Q2. FCOJ is also near the bottom end of its cycle along with the cotton market. Cotton is a commodity that is in the crosshairs of the trade dispute.

The potential for supply issues is always a danger when it comes to these agricultural commodities markets, and supply issues can cause explosive price moves like the one we witnessed in the cocoa market during the first and second quarters of 2018 and in coffee and sugar from the September 2018 lows through October 2018 highs. Risk-reward favors the commodities that are at multiyear lows, which is a sign that they are at a point in the pricing cycle where production will decline. The Brazilian real versus US dollar relationship is likely to impact the sugar, coffee, and FCOJ prices in Q3 as Brazil is the world’s leading producer and exporter of all three soft commodities. Domestic production costs are in local currency terms, so a rise in the Brazilian real would likely put upward pressure on dollar-based prices.

When it comes to trade issues, cotton continues to be the only soft commodity directly impacted by the tariffs and retaliation as the U.S. exports the fiber to China. Therefore, cotton could continue to experience wide price variance in Q3 as it did in Q2.

The lumber market hit a new low in Q2, but it closed the quarter significantly higher than the bottom price, which was a new low for the year and the lowest price since May 2016. 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.

Source: CQG

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 Q1, the price of lumber rose by 8.33%. In Q2, after trading to a low at $286.10, lumber posted a 5.19% gain and was 13.95% higher in the first half of 2019. The price of nearby lumber futures closed on June 28, 2019, at $378.90 per 1,000 board feet. So far in 2019, lumber traded in a range from $286.10 to $453.90 per 1,000 board feet and closed at the end of June just above the middle of its trading band for the first half of the year.

Lower interest rates in the US are likely to increase the demand for new home construction, which translates into more demand for wood, which is a critical industrial commodity. The price of lumber futures moved higher as soon as it appeared that Fed cuts interest rates could be on the horizon.

Total open interest in the lumber market was at 2,659 contracts, which is only 13 contracts lower from the Q1 closing level.  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.

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. At the end of 2018, I wrote, “The low level of lumber futures going into 2019 could prove unsustainable as the price has moved so far on the downside over the past seven months. At the same time, if the Fed becomes less hawkish and the U.S. economy continued to grow, it is possible that we will see an uptick in the price of lumber as demand increases if new home construction rises.” Lumber moved higher over the first half of 2019, but not before it spiked to a lower low in a sign of the market’s penchant for extreme volatility at times. Lower interest rates during the second half of 2019 would likely support the price of wood.

Any bipartisan legislation for an infrastructure rebuilding program could cause a recovery rally in the lumber; however, it is unlikely that the House of Representatives and the Trump administration will agree on anything before the 2020 Presidential election.

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.

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 Invesco DB Agriculture product (DBA) includes an almost 16.75% 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 most recent top holdings of DBA include:

Source: Yahoo Finance

The soft commodities sector posted a 2.82% loss in Q2.

Source: Barchart

As the chart of DBA illustrates, it moved from $16.47 at the end of Q4 to $16.57 at the end of Q2, a gain of 10 cents or 0.61%. The move higher was supported by increases in grain prices in Q2, which likely caused DBA to post a gain for the quarter, but the prices of cocoa and coffee moved to the upside providing support for the ETF product.

The one constant in all of these agricultural commodities is that the growing world population continues to underpin prices, and 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. 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.

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.