- The soft commodities sector posts a 3.34% loss in Q3.
- All five soft commodities move lower in Q3
- Coffee and cotton have the worst quarter with losses of 6.56% and 5.38% respectively as the Brazilian real falls.
- Sugar falls 3.25% in Q3
- FCOJ edges just over 1% lower while cocoa posts a marginal loss
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 around 20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by over 26.6%, which amounts to over 1.60 billion people. More people with more money consumes more coffee, cocoa, sugar, cotton, and orange juice each day, which underpins the prices of these commodities.
The composite of five soft commodities sugar, coffee, cocoa, cotton, and frozen concentrated orange posted two straight years of gains in 2015 and 2016. At the end of 2017, soft commodities were down just 2.25% on the year. In 2018, they finished with a loss of 5.68%. In Q1, the soft commodities composite declined by 1.08%, and Q2 the sector slipped by another 2.82%. In Q3 the losses continued as the soft commodities fell by 3.34%, making the total loss over the first nine months of 2019 7.61%.
The dollar index moved 3.51% higher in Q3, and 3.43% to the upside over the first nine months of the year after moving 4.26% higher in 2018. The dollar moved considerably higher against the Brazilian real in 2018, and the real remained weak in Q1 with other emerging market currencies. However, the Brazilian currency gained back around 1.6% in Q2. In Q3, the real fell by 8.1%. Brazil is the world’s leading producer of three of the five commodities in the sector, including sugar, coffee, and oranges. The weak real weighed on the prices of the three commodities in Q3. 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 Q4, it will be the weather and crop issues that determine the path of least resistance of prices as demand will continue to favor higher lows. However, the impact of demand can be slow and steady while supply gluts or deficits tend to shock markets and cause the most significant price moves on both the up and the downside.
While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes just under a 16.7% 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 fell in Q3, but some of the individual markets could be at or near the bottom ends of their trading ranges as of September 30.
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 over the first nine months of 2019. Ample supplies of sugar had caused the commodity to make a series of lower highs and lower lows from 2011 through August 2015 when the sweet commodity traded down to 10.13 cents per pound. Sugar then proceeded to rally, making a series of higher lows and higher highs culminating with the highs in late September 2016 at 23.90 cents per pound. From late 2016 through the end of September 2018 the sweet commodity moved lower making a series of lower lows reaching a bottom at 9.83 cents per pound on the nearby ICE world sugar futures contract in late September 2018 as the nearby ICE futures contract was expiring. Nearby sugar futures that trade on the ICE settled on September 30, 2019, at 11.92 cents per pound as it moved 3.25% lower in Q3 and was 0.91% lower over the first nine months of 2019.
Sugar prices traded as high as 36 cents per pound in February 2011. In countries like the US and the EU, the price of sugar is subsidized by the government. However, the major sugarcane producers, Brazil, Thailand, and India sell their crops at world market prices. Even in these countries, the government occasionally adopts policies to support sugar producers.
In Brazil, the weakness of their currency, the real, 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 was under pressure in Q3, but the price of ethanol rose in Q3, which pulled the price of sugar in opposite directions. 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 and gained 24.37% so far in 2019. While Brazil processes sugar into ethanol, the US refines corn into the biofuel. The level of the real against the dollar fell from $0.256110 against the US dollar at the end of Q2 to $0.2399 at the end of Q3. At the same time, crude oil edged lower from $58.47 per barrel at the end of Q2 to the $54.07 level at the end of Q3 which was not a bullish factor for the price of sugar since it is the primary ingredient in the production of an alternative fuel in Brazil.
After five straight years of surplus conditions, the sugar market went into a small deficit in 2015/2016, and that imbalance had increased in the 2016/2017 crop year. The price of sugar rose to 23.90 cents per pound in October 2016, which was the peak. The higher price caused an increase in production, and the deficit turned into a surplus in the sugar market, which weighed on the price throughout 2017 and much of 2018. At the same time, the Brazilian real declined against the U.S. dollar in 2018, falling from 0.32 to under the 0.24 level, which put additional pressure on the sugar price. However, the bounce in the real in Q4 was one of the reasons that sugar recovered Q4. The real moved back to the lows in Q4, which weighed on the price of the sweet commodity and sent it over 3% lower over the past three months.
As the weekly chart of the Brazilian currency against the dollar shows, the real plunged from 0.32 against the dollar in late January of this year to a low of 0.23625 in Q3 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 0.28035 in late October as a far-right wing and anti-corruption leader won the Presidency. The election of Jair Bolsonaro led to a rebound in the currency against the dollar, which provided additional support for the sweet commodity and drove the price to a high at 14.24 cents per pound during Q4. The real ran into selling at the highs as the market is now waiting to see if the new leader follows through on his promises from the campaign trail. The real declined from a lower high at $0.27475 in early Q1 which helped to push the price of nearby ICE sugar futures to around the 12.50-cents per pound level. 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 $0.2375, not far above its multiyear low. The weakness in the Brazilian currency weighed on the price of sugar in Q3.
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 at 10.68 in September.
The sugar market was in contango at the end of Q3, where deferred prices were higher than nearby prices on the forward curve.
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 2020 is not planted, and the weather, and crop or political events or changes in policies can alter the forward curve significantly and very quickly when they occur.
The quarterly chart of ICE sugar futures shows that since sugar fell to a low of 2.29 cents per pound back in 1985, the price had made higher lows during periods of oversupply. In 1985, there were 4.85 billion people on the earth, and at the end of Q3 2019, that number stands at over 7.60 billion, an increase of over 56.7% over the past thirty-four years. The number of people on our planet has increased exponentially over the past three decades, which has increased demand for all agricultural commodities, and sugar is no exception. The quarterly chart remains in a downward sloping trend when it comes to price momentum but is in oversold territory and attempting to cross higher.
The monthly chart shows that price momentum is in the lower region of neutral territory. Sugar is limping into the fourth quarter with the Brazilian currency at the lows.
As the weekly chart illustrates, price momentum crossed to the upside from oversold territory at the end of Q3.
Weather conditions in primary growing regions around the world have created more than enough sugar to satisfy global demand, which sent the price to the lowest level in more than a decade. However, the weak Brazilian currency and increased Indian subsidies helped sugar move lower in 2018 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 time will tell if the sweet commodity can make a rebound over the final months of this year.
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 865,373 contracts at the end of Q3 and increased to 904,165 contracts at the end of Q3, a rise of 38,792 contracts or 4.48% over the past three months. The metric rose to almost 1.080 million contracts in Q3, which was an all-time high. Speculative trend-following shorts likely helped push sugar to lows of 10.68 cents per pound in Q3.
Sugar can be one of the most volatile commodities that trade, in past years daily historical volatility had exceeded 100%. At the end of Q3, daily historical volatility stood at 15.26%, which was 10.61% lower than it was on the final day of trading in Q2 2019. As we move forward into the final quarter of 2019, technical support for sugar stands at 10.68 cents and 9.83 cents per pound with resistance at 12.82, 13.50, and 14.24 cents per pound.
Sugar Outlook for Q4 2019
The break below the August 2015 low in 2018 was the result bearish fundamentals coming together when it comes to the Brazilian real, government subsidy policies in India, and cooperative weather conditions in growing regions around the world. These factors created an almost perfect bearish storm for the price of sugar that tool the sweet commodity to a low of 9.83 per pound in Q3. So far in 2019, the low has been higher at 10.68 cents.
Looking forward to the fourth quarter of 2019, 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 are primary factors when it comes to the direction of the price of sugar over the coming three months. I believe that the downside is limited, and upside could become interesting if the weather conditions interfere with production or if the real moves higher from the current depressed level against the dollar.
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 18-20 million people per quarter means that there are now over three-quarters of a billion more mouths to feed in the world than the last time sugar traded at its current price level. I am modestly bullish on the prospects for the sweet commodity going into the fourth quarter. I will be keeping a close eye on the Brazilian real over the coming weeks and months for clues about the price direction of the sugar futures market.
For those who do not trade in the futures and futures options market on the Intercontinental Exchange, two ETN and ETF products do a reasonable job tracking the price of futures in the sweet commodity. SGG is the ETN product, while CANE is the ETF. I tend to prefer ETFs to ETNs because the later makes the buyer assume the credit risk of the issue. CANE holds long positions in ICE futures contracts. When I buy sugar, I’d rather assume the price risk of the commodity without additional risks that may result in surprises. The ETF offers a more direct route to the price action in the commodity without the extra level of risk.
I will continue to be a cautious buyer on price weakness and seller on rallies to take profits as I will approach sugar from the long side of the market. As the new leader of Brazil continues to make reforms, we could see the Brazilian currency move higher against the dollar, which would support gains in the price of sugar. However, that has yet to materialize. At the same time, the ever-expanding addressable market for sugar and the always-present danger of a weather-related issue could cause lots of volatility over the coming year. At under 12 cents per pound, I continue to prefer to trade sugar from the long side of the market.
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% and was 0.69% lower over the first nine months of 2019. Nearby ICE coffee futures closed on September 30, 2019, at $1.0115 per pound. The price range over the first half of this year was from $0.8635 on the lows to $1.1950 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 has been making lower highs and lower lows since November 2016 when the price peaked at $1.7600 per pound.
The weekly chart highlights that coffee futures have been in a bear market since November 2016. In Q4 2018, coffee violated the pattern of lower highs, and lower lows as the price rose to $1.2550 and above a level of technical resistance at the early June 2018 high at $1.2495 before turning lower once again. Meanwhile, price momentum on the weekly chart was in neutral territory at the end of Q3.
The daily chart of the active month December ICE coffee futures contract illustrates that price momentum was in neutral territory.
Meanwhile, the monthly chart displays a market at the lower end of a neutral condition with technical support now at the recent low at 86.35 cents and the September 2005 bottom at $0.8445 per pound. Open interest had been trending higher with the bearish price action, which is a technical validation of the downward trend in the coffee futures market. However, the metric corrected in Q2 and Q3.
Open interest in coffee futures edged lower over the past three months. Open interest stood at 266,452 at the end Q2 and fell to 264,672 at the end Q3 a decline of only 1,780 contracts or 0.67% over the third quarter of 2019. Open interest rose to a new record high in Q1 of this year at over 357,000 contracts.
Coffee futures were in steep contango at the end of Q3, a sign of oversupply in the coffee market.
Starbucks (SBUX) and Dunkin’ Brands Group (NASDAQ: DNKN) are both significant consumers of coffee beans, and the soft commodity is a primary cost of goods sold component for their earnings metrics. Strength in the stock market combined with the benefit of a lower price for coffee over the past three months pushed SBUX higher in Q3, but DNKN suffered a marginal loss for the quarter that ended on Monday.
As the chart shows, DNKN stock moved from $79.66 per share at the end of Q2 to $79.36 and the end of Q3, a decline of 0.38% over the three-month period. DNKN shares moved to a high at $84.73 on September 5 and corrected lower.
Shares of SBUX also moved higher in Q3 and outperformed DNKN.
As the chart shows, SBUX shares moved higher from $83.83 at the end of Q2 to $88.42 at the end of Q3, a gain of $4.59 or 5.47% over the three months. The lower price of coffee and strong stock market combined to push SBUX higher over Q3. Both SBUX and DNKN have both posted substantial gains over the first nine months of 2019.
Coffee Outlook for Q4 2019
Coffee is a highly volatile agricultural commodity. The demand side of the fundamental equation in the coffee market is compelling based on the ever-increasing addressable market. However, the price pressure has come from a glut of supplies and a weakening currency in the world’s leading producer of Arabica beans, Brazil, which fostered a continuation of production. While coffee recovered to $1.2550 per pound in mid-October 2018, the price fell back to a new and lower low on the nearby ICE futures contract in Q2 2019 in a sign of continued weakness 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. However, 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, 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. At around $1 per pound level, there is always a chance that the price could once again head for the recent low. The next level of technical support on the long-term chart is at the 2005 low at 84.45 cents and then at the Q4 October 2001 low at 41.50 cents per pound, more than half the current price level. Coffee recovered, and I continue to believe that the price offers value at anywhere near the $1 per pound level.
Meanwhile, coffee traded at over $2 per pound in 2014, and above the $3 level in 2011, 1997, and 1977. Weather and annual supplies of coffee beans is the chief determinant of the path of least resistance for the price of the soft commodity. Coffee inventories can provide a challenge each year as the commodity rots and deteriorate over time. Therefore, with the fickle nature of weather and production each year, the potential for upside gains from the current price level is compelling while increasing global demand should limit the downside. The price of coffee had done nothing but make lower highs and lower lows since November 2016. However, the swift move to $1.2550 in October 2018 was a sign that coffee’s price momentum can turn on a dime. I continue to favor long positions in coffee, going into Q4.
The potential for coffee is a compelling story as it remains near the bottom of its pricing cycle. A rebound in the Brazilian real would likely send the price of the soft commodity higher. The ICE futures and futures options market is the most direct route for a long position in the coffee market. However, the JO ETN product is an instrument that attempts to replicate the price action in the futures market. Coffee had been more than a frustrating market from the long side, but at the current price, production and inventories could begin to decline as demand is steadily rising. The frustration continued in Q3, but the price did not trade much below 90 cents. A weather event, rising Brazilian real, or the power of increasing demand will eventually cause the price of coffee to find a bottom and turn higher in a sustained move. The coffee futures market has a long history of explosive volatility. At the current price, I continue to believe the risk-reward of a long position in coffee continues to favor the upside.
Cocoa 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 that posted a gain as it fell by only 0.33% and was 1.08% higher over the first nine months of 2019. As of the close of business on September 30, 2019, nearby ICE cocoa futures were trading at $2442 per ton. Cocoa futures traded in a range of $1901-$2606 per ton over the first nine months of this year. The lows so far this year at $1901 was a one-day event during the roll from March to May futures. Otherwise, cocoa traded above the $2100 per ton level in 2019. The high came in Q3 in early July.
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. The Ivory Coast and Ghana are working on a minimum price for their production, which could support prices over the coming months.
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. The new Prime Minister pledged to take the UK out of the EU and deliver Brexit with or without a deal with the EU by October 31, which sent the pound to new lows against the US dollar at just below the $1.20 level. The price of cocoa fell with the pound. However, the UK Parliament made it illegal for the Prime Minister to exit the EU without a deal and the pound recovered to above the $1.25 level. The price of cocoa futures moved higher with the pound.
Open interest in ICE cocoa futures increased from 263,024 contracts at the end of Q2 to 305,406 contracts at the end of Q3, a rise of 42,382 contracts or 16.11% over the past three months. Cocoa open interest reached a new record high at 310,808 in Q3 last year on May 31, 2018, and was approaching that level at the end of the third quarter. Price momentum on the daily chart was crossing lower in overbought territory at the end of Q3, while the weekly chart was in neutral territory and rising, and 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 is now trading at the $2442 per ton level as we move into Q4.
The forward curve in the cocoa futures market was in a small contango from December 2019 through March 2020 and then moves into a minor backwardation from March 2020 out to July 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. Both nations are moving to establish minimum selling prices and production quotas to increase efficiency in the cocoa market.
Cocoa Outlook for Q4 2019
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 is rising gently in neutral territory at the end of Q3.
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 early-July high at $2602 is a resistance level, and $2000 on the downside is a critical psychological level for the cocoa futures market.
The NIB ETN product does a reasonable job replicating the price action in the ICE cocoa futures market which is the best route for direct investment in the price of the primary ingredient in chocolate other than the futures arena. Any supply issues in West Africa could cause surprises in this soft commodity. For the coming quarter, I am cautiously bullish for the prospects of cocoa futures and the NIB ETN product as the market has made a series of higher lows since late 2017. Buying cocoa on dips and taking profits at higher highs has been the optimal approach to the futures market and the NIB ETN product since late 2018, and that is likely to continue.
Cotton 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 and was 17.24% lower over the first nine months of 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.
As the weekly chart highlights, in Q3 cotton futures fell to a new low. On the active month futures contract, cotton traded in a range from 56.19 cents to 79.57 cents so far in 2019, and the price closed closer to the lows than the highs at the end of Q3. Nearby ICE cotton futures settled on September 30, 2019, at 59.75 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 the September WASDE report, the USDA told the cotton market that US production, beginning stocks, exports, and consumption fell, while world stocks increased. However, some positive news on trade developments trumped the WASDE, and the price of cotton broke back through the 60 cents per pound level on the upside and was trading around that level at the end of Q3.
The USDA said:
“The 2019/20 U.S. cotton estimates include lower beginning stocks, production, exports, and consumption, while ending stocks are unchanged. Beginning stocks are reduced 400,000 bales this month, reflecting 2018/19 reported ending stocks data from the WASDE-592-5 Farm Service Agency and the NASS Cotton System Consumption and Stocks report. Production is lowered 654,000 bales to 21.9 million, largely due to a decline for the Southwest, while consumption is lowered 100,000 bales reflecting recent activity. Exports are projected 700,000 bales lower due to reduced U.S. production and a lower projected U.S. share of world trade. The 2019/20 season-average price for upland cotton is forecast at 58 cents per pound, down 2 cents from last month. In both the 2017/18 and 2018/19 U.S. cotton balance sheets, the estimate for unaccounted cotton is revised downwards and exports are revised upwards. The unaccounted element of the U.S. cotton balance sheet has been growing in recent years, indicating an imbalance in the sum of the other components. The estimates for production, consumption, and stocks have maintained their consistency over this time, but a growing difference has occurred between the sources available for estimating U.S. exports. For 2017/18, exports are raised 432,000 bales, and unaccounted is reduced 332,000 bales. For 2018/19, exports are raised 546,000 bales, and unaccounted is 546,000 bales lower than the result based on the methodology used in past years. In each marketing year, revised exports are estimated as the average of the export levels reported by the Bureau of the Census and USDA’s Export Sales Reporting System. See the Foreign Agricultural Service’s Cotton: World Markets and Trade for more details on the export change and the Economic Research Service’s Cotton and Wool Outlook for a detailed explanation of the stocks calculation. The 2019/20 world estimates this month show higher beginning stocks, but lower production, consumption, and world trade. Production is forecast 709,000 bales lower as reductions for the United States and Australia offset an increase for India. Consumption is forecast 1.3 million bales lower than in August, with lower estimates for China, India, Brazil, Thailand, Vietnam, and the United States offsetting an increase for Turkey. World trade is lower as lower imports are forecast for China, Vietnam, and Thailand. World ending stocks for 2019/20 are forecast 1.3 million bales higher this month, at 83.7 million bales, 2.9 million bales above the revised 2018/19 estimate.”
Meanwhile, the trade issues between the United States and China had weighed on the price of cotton. 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. A trade deal between the two nations would likely be bullish news for the price of cotton in Q4. A continuation of an escalation of protectionist policies would not be a supportive factor for the price of the fiber.
As the forward curve demonstrates, term structure in cotton futures is in contango from October 2019 through July 2021 and then flattens out.
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 Q2 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 Q4, given its impact on the Chinese and global economic conditions.
Open interest in the fiber moved higher from 175,945 at the end of Q2 to 235,477 at the end of Q3 a rise of 59,532 contracts or 33.84% in Q3. Falling price and rising open interest are typically a validation of a bearish trend in a futures market. The metric hit a new all-time high in early June 2018 when it rose to 322,153 contracts.
The daily chart of December cotton futures highlights that cotton recovered from its price action below the 60 cents per pound level at the end of Q3. Technical resistance and support levels are at 55.66 cents and 70 cents per pound. Trade issues between the US and China and the 2019 crop will be the most significant issues facing the cotton market in Q4.
Cotton Outlook for Q4 2019
Cotton had been making upside progress since hitting bottom at 55.66 cents per pound in March 2016. In 2016, the price recovered to a high of 77.80 cents. In 2017, the high was at 87.18 cents per pound. In 2018, the price reached a high at 96.50 cents.
As the quarterly chart highlights, cotton has been making higher lows since 2001 when the price traded to lows of 28.20 cents per pound. In 2011, a shortage took the price to highs of $2.27, but since correcting to 55.66 cents the fiber had been making higher lows and higher highs. However, in Q2, the nearby cotton futures contract put in a bearish reversal on the quarterly chart which sent the price below the 60 cents level in Q3. The price was back around 60 cents at the end of Q3 waiting for the next news on trade between the US and China.
Cotton is a highly volatile commodity on the futures market and at times, suffers from a lack of liquidity during significant price moves. The results of trade negotiations with China are likely to make or break the price of the fiber in Q4.
BAL is the cotton ETN product, while it continues to build critical mass, the new instrument continues to suffer from a significant lack of liquidity. However, average trading volume moved from 2,112 shares as of the end of Q2 to 8,238 contracts at the end of Q3. The cotton futures and futures options market on ICE is the direct route for trading the fiber. Cotton is a market that can be wild at times and is not for the faint of heart as it requires market participants to take lots of risks. The price of cotton can move significantly on a percentage basis, so the potential for rewards balances the risks in the fluffy fiber futures. At around 60 cents per pound, I believe cotton is at or near the bottom end of its pricing cycle at the end of Q3.
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 Q3. 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 was 20.3% lower over the first nine months of 2019 making it the worst-performing soft commodity. Orange juice traded in a range of $0.9030 to a high of $1.3395 per pound over the first nine months of 2019 and settled on September 30, 2019, at 99.75 cents per pound. FCOJ fell to its lowest price since 2009 in Q2.
As the weekly chart highlights, FCOJ futures have made lower highs and lower lows since June 2018. Brazil is the world’s leading orange producing nation. The lower level of the Brazilian currency, the real, weighed on the price of FCOJ in 2018 and in 2019. Over the past 40-plus years, FCOJ futures had traded as low as 37.4 cents and as high as $2.35 per pound. In Q4 of 2016, OJ rose to the highest level in history. Most recently, the FCOJ price rose to over the $1.70 level because of a shortage of oranges from Brazil, the world’s leading producer of the citrus fruit, but the price moved lower from Q4 2018 through Q3 2019. The price of FCOJ futures tends to be highly sensitive to weather conditions in Florida over the winter season as freezes can cause significant rallies in the futures market. Over the recent winter, the price of the commodity slumped. Open interest decreased from 19,259 at the end of Q2 to 17,788 at the end of Q3, a decline of 7.64%. 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.
The forward curve in the FCOJ futures market is in a steady contango out to July 2022, which is a sign of ample supplies.
OJ is a thin and illiquid market that is dangerous as it is susceptible to price gaps when the price is moving. However, at the $1 per pound level, FCOJ futures are at a level from where they bounced higher and often recovered over the past decade.
FCOJ Outlook for Q4 2019
Just like in many other agricultural commodities futures market, the price of FCOJ futures has been making higher lows for more than a decade.
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. Coming into the winter months in the US where the potential for Floridian freezes rise, the market could be 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. I will be looking for open interest to decline and volume to dry up as a sign that a reversal to the upside is on the horizon over the coming days and weeks, which is what has happened over the recent weeks. A drop in the metrics could be a sign that the selling that plagued the market since mid-2018 is drying up. Volume and open interest tend to begin to increase once a trend gets underway.
The bottom line and a quick look at lumber
None of the five soft commodity prices moved higher in Q3. Coffee remains near the bottom end of its pricing cycle along with sugar, cotton, and FCOJ futures. Cotton is a commodity that is in the crosshairs of the trade dispute.
The potential for supply issues is always a danger when it comes to these agricultural commodities markets, and supply issues can cause explosive price moves like the one we witnessed in the cocoa market during the first and second quarters of 2018 and in coffee and sugar from the September 2018 lows through October 2018 highs. Risk-reward favors the commodities that are at multiyear lows, which is a sign that they are at a point in the pricing cycle where production will decline. The Brazilian real versus US dollar relationship is likely to impact the sugar, coffee, and FCOJ prices in Q4 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 Q4 as it did in Q3.
The lumber market edged lower in Q3. 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 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 but was 10.41% higher in the first nine months of 2019. The price of nearby lumber futures closed on September 30, 2019, at $367.10 per 1,000 board feet. So far in 2019, lumber traded in a range from $286.10 to $453.90 per 1,000 board feet and closed at the end of September just below the middle of its trading band for the year. Lumber futures did not move outside of its 2019 range in Q3.
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. At the same time, we are coming into a time of the year when construction projects slow during the winter months.
Total open interest in the lumber market was at 2,046 contracts, which is 613 contracts lower from the Q2 closing level. Lumber futures tend to trade less than 1,000 contracts each day. A day where more than 1,000 contracts change hands often occurs when a significant trend is underway.
Lumber is not a liquid market, and I would discourage anyone from trading in this market. However, lumber is a vital benchmark commodity, and it behooves all investors to monitor the price action as it provides clues about economic conditions and demand for industrial raw materials. At the end of 2018, I wrote, “The low level of lumber futures going into 2019 could prove unsustainable as the price has moved so far on the downside over the past seven months. At the same time, if the Fed becomes less hawkish and the U.S. economy continued to grow, it is possible that we will see an uptick in the price of lumber as demand increases if new home construction rises.” Lumber moved higher over the first nine months of 2019, but not before it spiked to a lower low in Q2 in a sign of the market’s penchant for extreme volatility at times. Lower interest rates during the final quarter of 2019 would likely support the price of wood.
Any bipartisan legislation for an infrastructure rebuilding program could cause a recovery rally in the lumber; however, it is unlikely that the House of Representatives and the Trump administration will agree on anything before the 2020 Presidential election.
WOOD and CUT are top lumber products that trade on the stock exchange. WY is a company that operates as a real estate investment trust in the lumber market with properties in the US and Canada. WOOD, CUT, and WY shares tend to move higher and lower with the price of lumber.
Soft commodities prices are some of the most volatile in all of the sectors of the raw materials asset class. These commodities tend to move to the top and bottom ends of their pricing cycles often, and the weather conditions around the world along with crop diseases and acts of nature can wipe out annual crops in the blink of an eye at times.
The Invesco DB Agriculture product (DBA) includes an almost 16.70% 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 3.34% loss in Q3.
As the chart of DBA illustrates, it moved from $16.57 at the end of Q2 to $15.86 at the end of Q3, a loss of $0.71 or 4.28%. Declines in corn and wheat weighed on the DBA product in Q3.
The one constant in all of these agricultural commodities is that the growing world population continues to underpin prices, and as demand rises each year, the world depends on growing supplies. In years where production is abundant, prices do not feel the impact of the rising demand. However, when shortages develop, price action can become explosive. Soft commodities can be one of the most volatile sectors of the commodities market, and the price variance often occurs when market participants least expect price moves. Q4 and 2020 have 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.