- Soft commodities move higher in Q2.
- Three of the five soft products moved higher during the second three months of 2020.
- Cotton and sugar post a double-digit percentage gain.
- Coffee posts a double-digit percentage loss in Q2
- FCOJ was higher while the cocoa price slipped
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. The population of the world is growing by around 20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by approximately 27.6%, which amounts to over 1.660 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 over the first six months of 2020 weighed on all markets, and soft commodities were no exception. In Q2, the sector made a bit of a comeback.
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 an 8.79% loss for the three months, in Q2 it recovered by 4.24% and was 5.61% lower through the first half of this year.
The dollar index moved 1.76% lower in Q2, which supported 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. In Q2, it made an even lower low at $0.1673 in mid-May, before recovering slightly by the end of the quarter. 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. In Q2, sugar and FCOJ futures rallied, but coffee posted a loss. 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, putting a strain on supplies. As we head into the second half of 2020, 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 and Q2 will continue to impact the demand for soft commodities in Q3. 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 half of 2020.
While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes just under 18% 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. Q1 presented a unique set of challenges for the sector, but the sector edged higher in Q2. The prospects for Q3 and beyond 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 9.05 at the end of April, the lowest price since 2007. Sugar traded in a range of 9.05 to 15.90 cents over the first six months of 2020. Nearby sugar futures that trade on the ICE settled on June 30, 2020, at 11.96 cents per pound as it moved 14.78% higher in Q2 and was 10.88% lower during the first half of the year.
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 Q2, and the price of ethanol hit bottom in Q2, which was not supportive of the price of sugar. Ethanol fell to a new record low at just under 80 cents per gallon in April 2020. Ethanol moved 33.75% lower in Q1 on the back of a significant decline in gasoline and crude oil prices. In Q2, a recovery in energy pushed ethanol 33.92% higher. While the US refines corn into biofuel, Brazil processes sugar into ethanol. The level of the real against the dollar fell below the $0.17 level in Q2. The Brazilian real declined from $0.25050 against the US dollar at the end of Q4 2019 to $0.18300 at the end of Q2 2020 after reaching a low of $016730. At the same time, crude oil plunged from $61.06 per barrel at the end of Q4 to below zero in Q2 before recovering to the $40 per barrel level, which was a reason for wide price volatility in the sugar futures market. Sugar fell to a thirteen year low in Q2 before recovering. 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 0.17 level in 2020, which put 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 0.16 in Q2 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 9.05 cents in late April 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. In Q2, the new low in the Brazilian currency pushed sugar to its lowest price since 2007. The weakness in the Brazilian currency contributed to a decline in sugar over the first six 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 9.05 cents per pound in April. 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 made a comeback as the price of energy commodities recovered since late April.
The sugar market was in contango at the end of Q2 2020, where deferred prices were higher than nearby prices on the forward curve out to March 2021.
The forward curve in sugar futures highlights contango from July through March 2021 and moved between contango and backwardation through May 2023. The forward curve offers clues about the balance between supply and demand. The nearby prices indicate no supply concerns on the back of the Brazilian real and energy prices. Sugar cane for delivery in 2022 and 2023 is not planted, and the weather, and crop or political events or changes in policies and currency markets 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 7.660 billion, an increase of over 57.9% 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 below neutral territory when it comes to price momentum.
The monthly chart shows that price momentum was below neutral territory. Sugar is moving into Q3 with the Brazilian currency above the recent low and a rebound in oil, gasoline, and ethanol prices.
As the weekly chart illustrates, price momentum was heading into overbought territory at the end of Q2 as the short-term trend was higher.
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 and in Q2 2020 were signs that sugar reached the bottom of its pricing cycle, which led to price recoveries. 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. Q2 took the volatile sugar market to a new low, but the price recovered to just below the 12 cents per pound level on the nearby October futures contract at the end of June.
At a time when demand destruction gripped the crude oil market, OPEC and Russia decided to flood the market with the energy commodity. NYMEX crude oil dropped to negative territory, and gasoline below 38 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 9.05 cents per pound on the nearby futures contract. Sugar ended the second quarter just below the midpoint of the 2020 trading range. 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. The pandemic has taken a toll on Brazil with the second-leading number of cases and deaths behind the United States.
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. The price of subsidized sugar in the US trades at a far higher price (nearly double) the price of free-market world sugar futures.
Open interest stood at 1,015,678 contracts at the end of Q1 and decreased to 918,143 contracts at the end of Q2, a decline of 97,535 contracts, or 9.6% 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. It did not move appreciably higher as the price recovered. While declining open interest does not typically validate any price trend, 2020 is not a typical year as Coronavirus and volatility in the oil market combined to create a cocktail that led to price variance 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 Q2, daily historical volatility stood at 23.11%, which was 9.17% lower than it was on the final day of trading in Q1 2020. As we move forward into Q3, short-term technical support for October sugar stands at 11.39 cents per pound, with resistance at 12.40and 15.90 cents per pound, the 2020 peak.
Sugar Outlook for Q3 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 no exception. 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. In Q2, sugar dropped like a stone to a lower low at 9.05 cents but closed the second quarter not far below the midpoint for the year at just under 12 cents per pound.
Looking forward to Q3, uncertainty in all markets and all aspects of life in the US and around the globe remain 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. Ethanol and the Brazilian real recovered by the end of Q2, which provided support for the sugar futures market. We should expect lots of volatility in the sugar market as well as in all markets in Q3 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. In 2008, during the global financial crisis, sugar dropped to a low of 9.44 cents. By 2011, the price more than tripled to over 36 cents per pound.
The critical levels of technical support stand at the Q2 low of 9.05 cents, and then at 8.36 cents per pound, the 2007 bottom. On the upside, 15.90 cents, the high from early 2020 is resistance. The environment at the end of Q2 tells us to expect the unexpected in sugar and all markets and asset classes over the coming months. At the end of Q1, I wrote, “The potential for lower prices is high.” Sugar dropped to a thirteen-year low and the bottom of its pricing cycle. I expect sugar prices to move higher in the coming months and years, but the potential for periodic selloffs remains high. I would be a buyer of sugar futures or ETF products on any significant price corrections to the downside in Q3 and beyond.
For those who do not trade in the futures and futures options market on the Intercontinental Exchange, two ETN and ETF products do an excellent 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 a portfolio of 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. 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. I believe the overall fundamental equation in the sugar market continues to favor the upside at the 12 cents per pound level.
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%. In Q2, the selling continued, and coffee dropped another 15.94% and was 25.51% lower over the first six months of 2020. Nearby ICE coffee futures closed on June 30, 2020, at $1.0050 per pound. The price range over the first half of this year was from $0.9270 on the lows to $1.3310 on the highs. Coffee declined from January through early February and recovered in February and March and fell to a new low in Q2 in mid-June. The price closed above the lows as coffee bounced back to the $1 per pound level on June 30.
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 to $1.3840 per pound. At the end of Q1 2020, coffee futures were working their way back towards the late 2019 peak but fell short at a high of just below $1.31. In Q2, the price fell to a new low for the year at 92.70 cents, before recovering. Meanwhile, price momentum and relative strength on the weekly chart were near oversold readings at the end of Q2.
The daily chart of the active month May ICE coffee futures contract illustrates that price momentum was falling below neutral territory after the most recent peak at the end of June.
Meanwhile, the monthly chart displays a market where price momentum was heading lower and entering oversold territory at the end of the second quarter.
Open interest in coffee futures moved higher over the past three months. Open interest stood at 240,712 at the end Q1 and rose to 268,517 at the end Q2 2020, an increase of 27,805 contracts, or 11.55% over the second quarter of 2020. Open interest rose to a new record high at the start of Q2 2019 at over 357,000 contracts. Rising open interest and falling price tend to be a validation of a bearish trend in a futures market.
Coffee futures were in contango at the end of Q2, a sign of some oversupply in the 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 Q3 given the impact of coronavirus on Brazil.
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. In Q2, the stocks recovered with the stock market.
As the chart shows, DNKN stock moved from $53.10 per share at the end of Q1 to $65.23 and the end of Q2 2020, a rise of 22.84% 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. DNKN moved higher in Q2 on the back of the stock market and lower coffee prices.
Shares of SBUX also moved higher in Q2 for the same reason but underperformed DNKN.
As the chart shows, SBUX shares higher from $65.74 at the end of Q1 to $73.59 at the end of Q2, a gain of $7.85 or 11.94% over the three months. SBUX hit an all-time high of $99.72 per share in July 2019. The cost of goods sold for DNKN and SBUX declined in Q2 and the stock market rose, which caused the price of both shares to move higher. Meanwhile, SBUX underperformed the overall stock market, while DNKN outperformed in Q2.
Coffee Outlook for Q3 2020
Coffee is a highly volatile agricultural commodity. The demand side of the fundamental equation in the coffee market remains 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. Each price dip below the $1 and 90 cents per pound level proved unsustainable in a sign of a bottom end of the pricing cycle for the soft commodity.
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. The price has made higher lows since Q2 2019, with the latest bottom in Q2 at 92.70 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 the $1.3840 level in December 2019 was a sign that coffee’s price momentum can turn on a dime. Deflationary pressures on the back of Coronavirus and a weak Brazilian real could not support a significant rally in the coffee market. The price action in coffee was weak at the end of Q2.
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 Q3 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. In 2008, coffee futures fell to a low of $1.0140 per pound. By 2011, the price tripled in value to $3.0625. the level of stimulus over the past months weighs on the value of the dollar and other world currencies and could lead to an inflationary spiral in the coming months and years. At the $1 per pound level, coffee futures are closer to the bottom than the top of its pricing cycle.
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. I would look to buy coffee futures or the JO ETN product on a scale-down basis at below the $1 level, which has been a profitable strategy since 2018.
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%, and it moved another 2.80% lower in Q2. Over the first half of 2020, cocoa was 13.94% lower. As of the close of business on June 30, 2020, nearby ICE cocoa futures were trading at $2186 per ton. Cocoa futures traded in a range of $2172-$2998 per ton in 2020 and closed just above 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 and throughout Q2. 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 Q2 below the average price since 2015. Open interest in ICE cocoa futures decreased from 235,796 contracts at the end of Q1 to 217,524 contracts at the end of Q2, a decline of 18,272 contracts, or 7.75% in Q2. 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. Falling open interest and declining price is not a validation of a bearish trend in a futures market.
Price momentum on the daily chart was in deeply oversold territory at the end of Q2, 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 Q2 on a weak note, the soft commodity made a new high during the first three months of 2020 and traded in a wide range. $2000 per ton is a critical level for cocoa on the downside.
The forward curve in the cocoa futures market was in a small backwardation from September 2020 through May 2022, 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. The low level of the British pound, which closed Q2 at $1.2397 against the US dollar and was 6.73% lower in 2020, is another factor weighing on the price of cocoa futures.
Cocoa Outlook for Q3 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 and relative strength indicators were below 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.
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. In 2011, cocoa reached its all-time peak at $3826 per ton. A return of inflationary pressures could take cocoa higher in the coming years as the level of stimulus in 2020 is far higher than in 2008.
Technical support for cocoa futures on the weekly chart is at $2089 per ton. Resistance is at the Q1 2020 peak at $2998 per ton as we move into Q3.
The NIB ETN product does an excellent 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. 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 Q3 and beyond, which could defy technical and fundamental analysis. Cocoa was closer to the bottom than the top end of its pricing cycle at the end of Q2.
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%. In Q2, the fiber futures recovered by 19.26% and were 11.69% lower over the first half of 2020.
As the weekly chart highlights, in Q2, cotton futures fell to a new low of 48.35 cents per pound, the lowest price since 2009. The price recovered to over the 60 cents per pound level by the end of June. Nearby ICE cotton futures settled on June 30, 2020, at 60.98 cents per pound. Cotton futures traded in a range from 48.35 to 73.08 cents over the first half of 2020.
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 and Q2 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.
In its latest June WASDE report the USDA told the cotton market:
“The most significant revision to this month’s U.S. cotton supply and demand estimates is a 200,000-bale decrease in 2019/20 mill use, to 2.5 million bales. U.S. mill use in 2020/21 was also revised downward by 100,000 bales, and ending stocks are now projected at 7.3 million bales in 2019/20 and 8.0 million bales in 2020/21. While the 43 percent stocks-use ratio projected for 2020/21 is marginally higher than the year before, and is substantially above recent levels, it would still be below the 55 percent ratio realized in 2007/08. The 2020/21 world cotton projections include slightly smaller production, reduced consumption, and higher beginning and ending stocks. World ending stocks are 5.2 million bales higher this month, reflecting cuts to world consumption of slightly more than 2 million bales each in 2019/20 and 2020/21, and revised production estimates for Argentina starting with 2017/18 that added an additional 930,000 bales to stocks. World production in 2020/21 is revised downward by 215,000 bales as higher production in Argentina and Tanzania is offset by reductions for Turkey, Uzbekistan, and some smaller countries. World consumption in 2020/21 is revised downward due to changes in a number of countries, led by a 1-million bale reduction in the forecast for China and a 500,000-bale reduction for India. At nearly 105 million bales, world ending stocks in 2020/21 are expected to be their largest since 2014/15.”
Source: USDA June WASDE report
While US mill stocks declined, the USDA projected that global ending inventories would rise to the highest level since 2014/2015. However, cotton continued to rally in the aftermath of the June WASDE report in a sign that the price had declined to an unsustainable on the downside. The trade friction between the US and China and the global pandemic could cap the upside prospects for the fiber going into the second half of 2020.
As the forward curve demonstrates, term structure in cotton futures is fairly flat out to May 2023. The cotton curve has tightened despite the high level of global stocks, which could be a bullish sign for the fiber futures over the coming months and years.
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. In 2008, the price of cotton futures fell to a low of 36.70 cents per pound. A decline in production and inflationary pressures in the aftermath of the 2008 global financial crisis led to the rally that took cotton to an all-time high at $2.27 per pound in 2011.
Open interest in the fiber moved lower from 194,311 at the end of Q1 to 159,719 at the end of Q2, a decline of 34,592 contracts, or 17.8% in Q2. Falling open interest and rising price is not typically a validation of a bullish trend in a futures market, but the events over the first half of 2020 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 December cotton futures highlights that cotton reached a high of 73.00 per pound on January 13 and made lower highs and lower lows throughout the rest of the first 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. In Q2, the price of the fiber futures took the stairs higher with a series of higher lows and higher highs. Technical resistance and support levels on the December contract are at 65.80 cents and at 50.18 cents per pound. Cotton was trending towards the resistance level at the end of Q2. The state of the global economy and the weather conditions in growing regions in the third quarter will be the critical factors when it comes to the price direction of cotton futures on the Intercontinental Exchange. The global pandemic and trade issues between the US and China will influence the price of cotton as we head into the second half of this year.
Cotton Outlook for Q3 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. The global pandemic ended that trend in 2020.
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 and Q2 2020, cotton fell below the 2016 low to 48.35 cents, the lowest price since 2009. Moreover, the close below the Q4 2019 bottom at 59.90 caused a bearish key reversal trading pattern on the quarterly chart. However, the price did not follow through on the downside in Q2 and recovered to over 60 cents, which is a constructive technical factor for the cotton market as we move into the third quarter.
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 Q3. 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. If inventories begin to 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. If the price action between 2008 and 2011 is a model for the cotton market, any significant dips would be buying opportunities over the coming months.
BAL is the cotton ETN product that suffers from limited liquidity. The average volume of the ETN increased marginally in Q2. The average trading volume moved from 3,130 shares as of the end of Q1 to 3,153 contracts at the end of Q2. The cotton futures and futures options market on ICE is the direct route for trading the fiber. The limited liquidity in BAL makes bid-offer spreads wide. Use caution on any stops in the ETN product because of the lack of volume in the product.
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 sixty cents per pound, the odds continue to favor the upside, but the upside potential could be limited because of the pandemic and trade issues. The trend at the end of Q2 was higher as cotton was taking the stairs to the upside. An elevator ride lower is always a danger in volatile markets like cotton.
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 moved higher in Q2 2020. 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. In Q2, the bullish party continued as the soft commodity moved 5.91% to the upside. Orange juice traded in a range of $0.9120 to a high of $1.3200 per pound during the first six months of 2020. FCOJ settled on June 30, 2020, at $1.2730 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. In Q2, the price reached a peak at $1.32 and closed closer to the high than the low in 2020. Open interest decreased from 13,085 at the end of Q4 to 10,247 at the end of Q2 2020, a drop of 21.7%. 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 in Q1 and Q2.
The forward curve in the FCOJ futures market is in steady contango from September 2020 out to May 2023, which is a sign of more production in the coming months and years and adequate supplies.
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 and has been taking the stairs higher since late February.
FCOJ Outlook for Q3 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 at the beginning of 2020.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 June, the volume in the futures market was steady as the price rose. The recent trend was bullish in the OJ market.
The bottom line and a quick look at lumber
Three of the five soft commodity prices moved higher in Q2. Cotton was the star performer, but it rebounded from the lowest level in years as coronavirus and trade friction between the US and China created a downside spike at the end of Q1 and beginning of Q2. Cotton continued to trend higher at the start of Q3. Coffee was the worst-performing soft commodity as the price was back around the $1 per pound level. Sugar and FCOJ posted gains, while cocoa edged lower for the quarter. The Brazilian real made a new low in Q2 but bounced higher by the end of the quarter. The real remained below the $0.20 level against the US dollar, which was not a supportive factor for the prices of sugar, coffee, and FCOJ futures.
The potential for supply issues is always a danger when it comes to these agricultural commodities markets. The global economic meltdown in Q1 and into Q2 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 Q3, 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 half 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 Q2, the price of wood soared higher. 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 wood turned around in Q2 and posted a 55.65% gain and was 7.50% higher over the first six months of 2020. The price of nearby lumber futures closed on June 30, 2020, at $435.70 per 1,000 board feet. Over the first six months of 2020, lumber traded in a wide range from $251.50 to $477.70 per 1,000 board feet and closed at the end of June closer to the higher end of its trading band for the year.
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. Rates have dropped to historic lows, which is a positive sign for the housing market.
Total open interest in the lumber market was at 2,620 contracts, which is 204 contracts lower from the Q1 closing level as of the end of the second 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.
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, they all recovered with the price of wood and the performance of the stock market.
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 18% 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:
Source: Yahoo Finance
The soft commodities sector posted a 4.24% gain in Q2 2020.