• The soft commodities were the best-performing sector in Q4
  • Four of the five soft products posted gains during the final three months of 2019
  • Coffee exploded to the upside with an over 28% gain in Q4
  • Sugar and cotton post double-digit percentage gains and cocoa moved over 4% higher from October through December
  • FCOJ falls by around 2.6%

Soft commodities can be the most volatile sector of the commodities market as prices routinely double, triple, or halve in value during their pricing cycles. The path of least resistance for the prices of luxury commodities is a function of the weather and crop diseases in the critical growing areas around the world. However, the demand side of the fundamental equation reflects an ever-increasing addressable market for these products as the population of the world is growing by 15-20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by approximately 27%, which amounts to over 1.617 billion people. More people with more money consume 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 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 Q1, the soft commodities composite declined by 1.08%, and Q2 the sector slipped by another 2.82%. In Q3, the losses continued as the soft commodities fell by 3.34%. In Q4, the sector erased all of the 2019 losses and more as it rose 11.57%. In 2019 the soft commodities sector moved 3.47% to the upside.

The dollar index moved 2.99% lower in Q4, but 0.34% to the upside over in 2019 after moving 4.26% higher in 2018. The dollar moved considerably higher against the Brazilian real in 2018, and the real remained weak throughout 2019 with other emerging market currencies. The Brazilian currency posted a gain of around 1.6% in Q2. In Q3, the real fell by 8.1%. In Q4, it moved 4.42% higher. 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 2019 as it remained near the bottom end of its trading range since 2011. 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 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.

While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes just under an 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. The prospects for 2020 depend on the weather, the overall state of supplies, and currency markets.

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 10.68 to 14.64 cents in 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 2018, as the nearby ICE futures contract was expiring. Nearby sugar futures that trade on the ICE settled on December 31, 2019, at 13.42 cents per pound as it moved 12.58% higher in Q4 and was 11.55% higher in 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, 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 remained near the lows in Q4, and the price of ethanol fell in Q4, which was not supportive of the price of sugar. Ethanol fell to a new record low at under $1.20 per gallon in Q4 2018. Ethanol appreciated in Q1, and the price exploded by 11.9% in Q2 on the back of higher corn prices in the US. In Q3, ethanol prices were 4.45% higher. In Q4, the price fell sharply by 12.53%, cutting the gain to 8.78% in 2019. While Brazil processes sugar into ethanol, the US refines corn into biofuel. The level of the real against the dollar rose from $0.23990 against the US dollar at the end of Q3 to $0.25050 at the end of Q4. At the same time, crude oil moved higher from $54.07 per barrel at the end of Q3 to the $61.06 level at the end of Q4, which a bullish factor for the price of sugar since it is the primary ingredient in the production of 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 2018 was one of the reasons that sugar recovered. The real continues to trade a lot closer to its low than its high since 2011.

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 2018 to a low of 0.23680 in Q3 2018. 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 last year. 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. 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. In Q3, 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. The most recent bottom was not far above the real’s multiyear low. The weakness in the Brazilian currency did not stop sugar from moving to the upside in Q4.

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 Q3, the price of sugar fell through the bottom of its 2019 trading range to a low of 10.68 in September. However, in Q4, sugar futures rose to a new high for 2019 at 13.67 cents, which could have been inspired by the price action in the volatile coffee futures market.

The sugar market was in contango at the end of Q4, where deferred prices were higher than nearby prices on the forward curve.

Source: ICE/RMB

The forward curve in sugar futures highlights the steady contango out to March 2021, 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 in 2021 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 Q4 2019, that number stands at over 7.620 billion, an increase of over 57% 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 oversold territory when it comes to price momentum but is attempting to cross higher.

Source: CQG

The monthly chart shows that price momentum is in the lower region of overbought territory. Sugar is moving into 2020 with the Brazilian currency not far off its lows.

Source: CQG

As the weekly chart illustrates, price momentum was in overbought territory at the end of Q4.

Weather conditions in primary growing regions around the world have created more than enough sugar to satisfy global demand, which sent the price to the lowest level in more than a decade in 2018. The weak Brazilian currency and increased Indian subsidies also helped sugar move lower in 2018 and 2019. Subsidies and tariffs tend to distort commodities prices as they interfere with supply and demand fundamentals. Economic theory teaches that commodities flow from those producers with the lowest output costs to consumers around the world. Those producers whose cost of output is above the price buyers are willing to pay do not survive. When prices fall to a level where production declines, inventories begin to fall in response to growing demand. Demand typically increases at lower prices, which leads to a decline in inventories when output slows. The price action in Q3 and rebound in Q4 2018 were signs that sugar reached the bottom of its pricing cycle, which led to its recovery. Sugar was in a similar position at the end of Q3 2019, and the price posted a double-digit percentage gain in Q4. Time will tell if the sweet commodity can stage a significant rebound in the new decade.

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. India continues to practice protectionist policies. However, President Trump’s relations with President Modi could have some influence over Indian policies.

Open interest stood at 904,165 contracts at the end of Q3 and increased to 989,858 contracts at the end of Q4, a rise of 85,693 contracts, or 9.48% over the past three months. The metric rose to almost 1.080 million contracts in Q3, which was an all-time high. Rising open interest and increasing price in Q4 is a technical validation of an emerging bullish trend in a futures market.

Sugar can be one of the most volatile commodities that trade; in past years, daily historical volatility had exceeded 100%. At the end of Q4, daily historical volatility stood at 11.34%, which was 3.92% lower than it was on the final day of trading in Q3 2019. As we move forward into 2020, technical support for sugar stands at 10.68 cents and 9.83 cents per pound with resistance at 13.67 and 14.24 cents per pound.

Sugar Outlook for Q1 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. 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 the year.

Looking forward to 2020, nothing much has changed in the sugar market. The consolidation above last year’s low is a healthy sign for the sugar market. However, the price of ethanol in Brazil and the level of the Brazilian real will continue to be significant factors when it comes to the direction of the price of sugar during Q1 2020 and beyond. Given the price action in the coffee futures market during the fourth quarter of 2019, sugar has the potential to follow the other soft commodity in 2020.

The critical 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 15-20 million people per quarter means that there are more mouths to feed in the world each day, and the demand for sugar is ever-increasing. I am modestly bullish on the prospects for the sweet commodity going into 2020. 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 continues to make reforms, we could see the Brazilian currency move higher against the dollar, which would support gains in the price of sugar. In Q4, US President Trump slapped tariffs on Brazilian exports of steel and aluminum to the US because of the low level of the Brazilian currency versus the US dollar. The protectionist move could motivate Brazil to let its currency rise, which could 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 the price level at the end of 2019, 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. In Q3, coffee fell by 6.56%. In Q4, the price exploded to the upside and posted a 28.23% gain. Coffee futures were 27.34% higher in 2019, with all of the gains coming over the final three months. Nearby ICE coffee futures closed on December 31, 2019, at $1.2970 per pound. The price range 2019 was from $0.8635 on the lows to $1.4245 on the highs. Coffee fell to a lower low than the 2018 bottom in Q2, but the price did not reach that level in Q3. Coffee made 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 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. Meanwhile, price momentum on the weekly chart was in overbought territory at the end of Q4.

Source: CQG

The daily chart of the active month March ICE coffee futures contract illustrates that price momentum was falling towards oversold territory as the price was correcting from the most recent high.

Source: CQG

Meanwhile, the monthly chart displays a market where price momentum turned higher after rejecting the low at 86.35 cents per pound in April. Open interest had been trending higher with the bearish price action, which was a technical validation of the downward trend in the coffee futures market. However, it remained elevated through the recent rally to the highest price since 2017.

Open interest in coffee futures moved higher over the past three months. Open interest stood at 264,672 at the end Q3 and fell to 277,161 at the end Q4 a rise of 12,489 contracts or 4.72% over the fourth quarter of 2019. Open interest rose to a new record high at the start of Q2 2019 at over 357,000 contracts.

Source: ICE

Coffee futures were in contango at the end of Q4, a sign of some oversupply in the coffee market. However, the price of coffee rallied over concerns about an off-year for production in Brazil, the world’s leading producer and exporter of Arabica beans. The International Coffee Organization said that the 2019/2020 crop could be low compared to recent years, stoking fears of the supply-demand deficit in the global coffee market.

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. Despite record highs in the stock market, SBUX and DNKN shares moved lower, perhaps because of the rising price of coffee beans over the recent months.

Source: Barchart

As the chart shows, DNKN stock moved from $79.36 per share at the end of Q3 to $75.54 and the end of Q4, a decline of 4.81% over the three months. DNKN shares moved to a high at $84.73 on September 5 and corrected lower. The higher price of coffee likely contributed to the move in the stock.

Shares of SBUX also moved lower in Q4 but outperformed DNKN.

Source: Barchart

As the chart shows, SBUX shares slightly lower from $88.42 at the end of Q3 to $87.92 at the end of Q4, a loss of $0.50 or 0.57% over the three months. The lower price of coffee could have weighed on both stocks in Q4 despite record highs in the stock market. Both SBUX and DNKN both posted substantial gains in 2019.

Coffee Outlook for Q1 2020

Coffee is a highly volatile agricultural commodity. The demand side of the fundamental equation in the coffee market was compelling based on the ever-increasing addressable market. The price pressure had come from a glut of supplies and a weakening currency in the world’s leading producer of Arabica beans, Brazil, which fostered a continuation of production. However, prices below 90 cents per pound were unsustainable despite the weak level of the Brazilian currency.

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. In Q3 2018, the price action negated the pattern of higher lows as the price traded below $1 per pound for the first time since 2006. The low at 92 cents was the lowest since 2005. In Q2 2019, the bottom at 86.35 cents was the lowest since July 2005 when the price reached a bottom at 84.45 cents per pound. In Q3, the price remained above the Q2 low. In Q4, it took off on the upside. In a volatile market like coffee, the risk rises with the price of the soft commodity.

Meanwhile, coffee traded at over $2 per pound in 2014, and above the $3 level in 2011, 1997, and 1977. Weather and annual supplies of coffee beans is the chief determinant of the path of least resistance for the price of the soft commodity. Coffee inventories can provide a challenge each year as the commodity rots and deteriorate over time. Therefore, with the fickle nature of weather and production each year, the potential for upside gains from the current price level is compelling while increasing global demand should limit the downside. The price of coffee did nothing but make lower highs and lower lows from November 2016 through April 2019. However, the swift move to over the $1.40 level in December 2019 was a sign that coffee’s price momentum can turn on a dime. If the ICO is correct about supplies in the 2019/2020 crop year, much higher prices could be on the horizon for 2020. At the same time, any recovery in the Brazilian real would only add to the bullish prospects for the coffee market.

In Q3, I wrote, “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.” In Q4, an over 28% rise was a validation that the price was at the bottom end 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. I would be a buyer of coffee on any significant price corrections during Q1 2020.

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%. In Q3, cocoa was the best-performing soft commodity as it fell by only 0.33%. In Q4, cocoa moved 4.01% higher and was 5.13% higher in 2019. As of the close of business on December 31, 2019, nearby ICE cocoa futures were trading at $2540 per ton. Cocoa futures traded in a range of $1901-$2783 per ton in 2019. The low of $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. The high came in Q4 in mid-November.

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 $2606 per ton in early July when the price fell back below the $2100 level. Cocoa then recovered and made a higher high at $273 in November. 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, guaranty farmers a premium for their beans, and reduce child labor in the cocoa business.

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 is historically sensitive to moves in the British pound as London is the hub of the physical cocoa market, and physical deals use the pound as a pricing mechanism. However, the problems surrounding Brexit appears to have changed that relationship. Cocoa fell to lows in Q3 when Prime Minister Theresa May resigned, and Boris Johnson took over. On December 12, the general election handed the Prime Minister a significant victory, which should pave the way for Brexit by the end of January 2020. The pound rose to a high at just over $1.35 against the dollar in the aftermath of the election, and to the highest level since 2016 against the euro at 1.20. The stronger pound had little impact on the price of cocoa as the soft commodity had been correcting lower since mid-November.

Open interest in ICE cocoa futures decreased from 305,406 contracts at the end of Q3 to 281,569 contracts at the end of Q4, a decline of 23,837 contracts, or 7.81% in Q4. Cocoa open interest reached a new record high at 333,175 contracts during Q4 on December 12.

Source: CQG

Price momentum on the daily chart was rising from oversold territory at the end of Q4, while the weekly chart was in neutral territory and falling. The monthly chart was rising in the upper region of neutral 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 was trading at the $2540 per ton level as we move into 2020.

Source: ICE

The forward curve in the cocoa futures market was in a small contango from March 2020 through May 2020 and then moves into backwardation from May 2020 out to September 2021, which is not a bearish sign for the price of the soft commodity. Over 60% of the world’s annual supplies come from West Africa, which can make output and logistics problematic at times because of the fickle nature of African politics. At the same time, since cocoa is the primary revenue-producing commodity in the Ivory Coast and Ghana, child labor in those countries poses a moral dilemma for chocolate manufacturing companies and western governments in the US and Europe. A move to stop the number of children involved in the production process could increase the price of the soft commodity via the surcharge.

Cocoa Outlook for Q1 2020

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 in neutral territory at the end of Q4.

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 had been rising to new record highs, which is supportive of the price of cocoa beans. Price fixing by West African nations could help to support the price of the soft commodity.

Technical support for cocoa futures is at $1982 per ton as I am ignoring the one day move to $1901 as an anomaly. Resistance is at the 2018 peak at $2914 per ton as we move into Q4. From a shorter-term perspective, the mid-November high at $2783 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. In 2002, I am cautiously bullish for the prospects of cocoa futures and the NIB ETN product as the market has made a series of higher lows since late 2017. Buying cocoa on dips and taking profits at higher highs has been the optimal approach to the futures market and the NIB ETN product since late 2018, 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%. In Q3, the selling continued, and the price shed 5.38% of its value. In Q4, cotton moved 15.56% higher and was 4.36% lower in 2019. Cotton fell to a low at 56.19 in late August, which was the lowest price since 2016 and only 0.53 cents above the March 2016 low.

Source: CQG

As the weekly chart highlights, in Q3, cotton futures fell to a new low. The price staged a comeback in Q4. On the active month futures contract, cotton traded in a range from 56.19 cents to 79.57 cents in 2019, and the price near the middle of the trading range at the end of Q4. Nearby ICE cotton futures settled on December 31, 2019, at 69.05 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 Q3, the 60 cents per pound level gave way on the downside because of the escalation of the trade war between the US and China. In Q4, the announcement of a “phase one” trade deal lifted the price of the fiber futures. In the December WASDE report, the USDA told the cotton market that US production and ending stocks fell. Global stocks also dropped from the November report but were still higher than the previous year.

The USDA said:

This month’s outlook for U.S. cotton in 2019/20 includes lower production and ending stocks compared with last month. Production is lowered 611,000 bales mainly due to a 500,000-bale decline in Texas. Domestic mill use and exports are unchanged. Ending stocks are 600,000 bales lower this month, at 5.5 million. Upland cotton’s season-average farm price is also unchanged at 61 cents per pound. The global 2019/20 cotton forecasts include lower beginning stocks and production, largely offset by lower consumption. A nearly 900,000-bale decline this month in beginning stocks is led by a 700,000-bale reduction in India, following a report by India’s Cotton Advisory Board that lowered India’s 2018/19 cotton crop by a similar amount. World cotton production in 2019/20 is projected at 121.1 million bales, down 830,000 from November, and 3.0 million higher than in 2018/19. Production changes for 2019/20 this month other than the United States include decreases of 800,000 bales for Pakistan, 500,000 for India, and smaller declines for Australia, Turkey, and Chad. Partly offsetting are a 900,000-bale increase in Brazil’s projected crop, a 500,000-bale increase for Uzbekistan, and several smaller gains. A 1.2-million-bale decline this month in projected world consumption is led by a 1.0-million-bale reduction for China, due in part to lower textile exports. The consumption forecasts for Vietnam and Pakistan were also reduced, offsetting a small increase for Uzbekistan. WASDE-595-5 Global 2019/20 ending stocks are nearly 500,000 bales lower this month. At 80.3 million bales, total ending stocks are only projected about 600,000 bales higher than in 2018/19, but stocks outside of China are expected to rise 3.1 million bales from the year before.

Source: USDA December WASDE report

Meanwhile, the trade issues between the United States and China had weighed on the price of cotton, but progress on trade on December 13 lifted the price. Tariffs and retaliation distort prices and interfere with the flow of cotton from US producers to Chinese consumers. Tariffs and subsidies interfere with price dynamics as they distort supply and demand fundamentals. Further progress on trade in 2020 would be a supportive factor for the price of cotton futures. Any escalation of protectionist policies could send the price lower.

Source: ICE/RMB

As the forward curve demonstrates, term structure in cotton futures is in contango from March 2020 through July 2020 and then moved into a slight backwardation.

China and India are significant factors for the cotton market due to their domination when it comes to supply and demand for the fiber, and the US has trade issues with both nations. The stronger dollar in 2019 also weighed on the price of the fiber. Meanwhile, economic growth around the world will determine the demand for garments. The trade dispute with China will continue to be the most significant issue facing the cotton market in 2020, given its impact on the Chinese and global economic conditions.

Open interest in the fiber moved lower from 235,477 at the end of Q3 to 222,851 at the end of Q4, a decline of 12,626 contracts, or 5.36% in Q4. Falling open interest and rising price is not typically a validation of a bullish 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 March cotton futures highlights that cotton recovered from its price action below the 60 cents per pound level and moved higher throughout Q4. Technical resistance and support levels are at 57.65 cents and 70 cents per pound. Trade issues between the US and China, the global economy, and the 2020 crop will be the most significant issues facing the cotton market in 2020.

Cotton Outlook for Q1 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.

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. In Q3, cotton found a bottom at a higher low at 56.19 cents per pound.

Cotton is a highly volatile commodity on the futures market and, at times, suffers from a lack of liquidity during significant price moves. We could see a substantial move to the upside in the cotton market in the first half of 2020 if the progress towards a comprehensive trade agreement between the US and China continues.

BAL is the cotton ETN product, and it continues to build critical mass, but volumes decline in Q4. The average trading volume moved from 8,238 shares as of the end of Q3 to 4,265 contracts at the end of Q4, which could be for seasonal reasons. The cotton futures and futures options market on ICE is the direct route for trading the fiber. Cotton is a market that can be wild at times and is not for the faint of heart as it requires market participants to take lots of risks. The price of cotton can move significantly on a percentage basis, so the potential for rewards balances the risks in the fluffy fiber futures. At under 70 cents per pound, with progress on trade, I believe cotton can move higher in 2020.

Frozen Concentrated Orange Juice Review

Trading FCOJ futures is a frantic business; I would not recommend it to anyone because of the lack of liquidity. The orange juice futures market edged marginally lower in Q4. 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. In Q3, it slipped by 1.19%, and in Q4, FCOJ fell by 2.56%. The soft commodity was 22.33% lower in 2019, making it the worst-performing soft commodity for the quarter and year. Orange juice traded in a range of $0.9030 to a high of $1.3395 per pound in 2019 and did not move outside of the range in Q4. FCOJ settled on December 31, 2019, at 97.20 cents 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 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 Q4 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 winter of 2018, the price of the commodity slumped. The price remains depressed during the early winter months of 2019/2020. Open interest decreased from 17,788 at the end of Q3 to 17,058 at the end of Q4, a drop of 4.10%. 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 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 second half of December.

Source: ICE/RMB

The forward curve in the FCOJ futures market is in a steady contango out to November 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 around the $1 per pound level, FCOJ futures are at a level from where they bounced higher and often recovered over the past decade.

FCOJ Outlook for Q1 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.

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, but the volatile futures can be dangerous given the limited liquidity during price moves. Now that we are in the heart of the winter months in the US, there is always a potential for Floridian freezes, which make the futures market susceptible to upward price spikes.

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. In December, unusually higher volumes could be signaling that a price recovery is on the horizon. Volume and open interest tend to begin to increase once a trend gets underway.

The bottom line and a quick look at lumber

Four of the five soft commodity prices moved higher in Q4. Coffee was the star performer, but it rallied without the help of the Brazilian currency. Sugar also made strides on the upside during the final quarter of the year. Cotton is a commodity that is in the crosshairs of the trade war. But the “phase one” deal could propel the fiber higher in 2020. Cocoa ended Q4 with a price correction from the recent highs, but the surcharge on West African exports could create a higher low in 2020. FCOJ at below the $1 per pound level is near the bottom end of its pricing cycle.

The potential for supply issues is always a danger when it comes to these agricultural commodities markets. 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. Coffee displayed another such move in Q4. 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 2020, 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 2020 as it did throughout 2018 and 2019.

The lumber market posted a double-digit percentage gain in Q4, as the price moved back above the $400 level. 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. In Q3, the price of wood was 3.11% lower. In Q4, lumber was 10.41% higher and 21.89% higher in 2019. The price of nearby lumber futures closed on December 31, 2019, at $405.30 per 1,000 board feet. In 2019, lumber traded in a range from $286.10 to $453.90 per 1,000 board feet and closed at the end of December above the middle of its trading band for the year. Lumber futures did not move outside of its 2019 range in Q4.

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 3,277 contracts, which is 1,231 contracts higher from the Q3 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 in 2019. Lower interest rates should continue to 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 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 an 11.57% gain in Q4.

Source: Barchart

As the chart of DBA illustrates, it moved from $15.86 at the end of Q3 to $16.56 at the end of Q2, an increase of $0.70 or 4.41%. Declines in some of the agricultural commodities limited the upside performance of DBA in Q4. Moreover, the cost of rolling futures contracts in contango markets is a cost that the ETF product passes on to holders.

The one constant in all of these agricultural commodities is that the growing world population continues to underpin prices. As demand rises each year, the world depends on growing supplies. In years where production is abundant, prices do not feel the impact of the rising demand. However, when shortages develop, price action can become explosive. 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. 2020 has the potential to be a volatile time for this sector of the commodities market where prices routinely double, triple, and halve in value because of weather, crop disease, currency moves, and other exogenous factors.

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.