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 world’s critical growing areas. However, the demand side of the fundamental equation reflects an ever-increasing addressable market for these products. The population of the world is growing by around 20 million people each quarter. Since 2000, the number of people inhabiting our planet has increased by approximately 28.1%, which amounts to over 1.686 billion people, according to the US Census Bureau. More people with more money consume more coffee, cocoa, sugar, cotton, and orange juice each day, which underpins the prices of these commodities. However, the outbreak of Coronavirus in 2020 weighed on all markets, and soft commodities were no exception. In Q2 and Q3, the sector made a comeback.
The composite of five soft commodities, sugar, coffee, cocoa, cotton, and frozen concentrated orange juice, posted an 8.79% loss in Q1. In Q2, it recovered by 4.24%, in Q3, it rose by 7.41%. Soft commodities were 0.26% lower through the first nine months of this year.
The dollar index moved 3.52% lower in Q3, which supported the prices of all commodities. In Q3, the Brazilian real edged marginally lower. Brazil is the world’s leading producer of three of the five commodities in the sector, including sugar, coffee, and oranges. The real did not significantly impact the soft commodity prices in Q3 as the exchange rate against the dollar hardly moved. 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.
While there are ETF/ETN products for four of the five soft commodities, the Invesco DB Agriculture product (DBA) includes an over 18% exposure to the three of the most active in the sector as it holds positions in sugar, coffee, and cocoa futures contracts. The soft commodity sector rose in Q4 and 2019. Q1 presented a unique set of challenges for the sector, but the sector edged higher in Q2 and Q3. The prospects for Q4 and beyond depend on the weather, the overall state of supplies, currency markets, and, most significantly, the global pandemic.
Sugar traded in a range of 9.05 to 15.90 cents over the first nine months of 2020, remaining within that band in Q3. Nearby sugar futures that trade on the ICE settled on September 30, 2020, at 13.51 cents per pound as it moved 12.96% higher in Q3 and was 0.67% higher so far in 2020.
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.
As the weekly chart illustrates, price momentum was well above a neutral reading at the end of Q3 as the short-term trend was higher.
In Q1, drought conditions in Thailand lifted the price to 15.90 cents before risk-off conditions created by the Coronavirus sent the price lower. Q2 took the volatile sugar market to a new low, but the price recovered to just above the 13 cents per pound level on the nearby March 2021 futures contract at the end of September.
At a time when demand destruction gripped the crude oil market, OPEC and Russia decided to flood the market with the energy commodity. NYMEX crude oil dropped to negative territory, and gasoline below 38 cents per gallon on the nearby futures contract. The combination of factors weighed on the price of sugar and sent the price from 15.90 to 9.05 cents per pound on the nearby futures contract. Sugar ended the third quarter above the midpoint of the 2020 trading range. Coronavirus continues to be the worst pandemic to grip the world since the 1918 Spanish flu, and the price of crude oil remained near the low. The pandemic has taken a toll on Brazil with the second-leading number of cases and deaths behind the United States. The coming months will determine if lockdowns because of COVID-19 leaves the world with too much or too little sugar.
Meanwhile, production subsidies or tariffs interfere with the fundamentals of efficient markets. Therefore, supply and demand analysis become challenging in markets where governments support businesses that are losing money or where they restrict the flow of goods around the world. When government-subsidized products flood international markets, they damage economic conditions in other nations where governments do not provide aid to producers. The price of subsidized sugar in the US trades at a far higher price (nearly double) the price of free-market world sugar futures.
Sugar can be one of the most volatile commodities that trade. As we move forward into Q4, short-term technical support for March sugar stands at 12.44 cents per pound, with resistance at 13.77 and 15.90 cents per pound, the 2020 peak on the continuous futures contract.
In Q1, the price of coffee declined by 7.83%. In Q2, the selling continued, and coffee dropped another 15.94%. In Q3, coffee made a comeback and was 10.40% higher but was still 14.46% lower over the first nine months of 2020. Nearby ICE coffee futures closed on September 30, 2020, at $1.1095 per pound. The price range so far in 2020 was from $0.9270 on the lows to $1.3545 on the highs. Coffee made a marginal new high for the year in Q3.
At the end of Q1 2020, coffee futures were working their way back towards the late 2019 peak but fell short at a high of just below $1.31. In Q2, the price fell to a new low for the year at 92.70 cents before recovering. In Q3, the price rose to a lower high of $1.3450 before correcting lower at the end of the quarter. Meanwhile, price momentum and relative strength on the weekly chart were on either side of neutral readings at the end of Q3.
Starbucks (SBUX) and Dunkin’ Brands Group (NASDAQ: DNKN) are both significant consumers of coffee beans, and the soft commodity is a primary cost of goods sold component for their earnings metrics. The massive selling in the stock market sent the prices of both SBUX and DNKN shares substantially lower. In Q2 and Q3, the stocks recovered with the stock market.
As the chart shows, DNKN stock moved from $65.23 per share at the end of Q2 to $81.91 and the end of Q3 2020, a rise of 25.57% over the three months. DNKN shares moved to an all-time high at $84.73 on September 5, 2019, and tanked in Q1 as the black swan event hit markets. DNKN moved higher in Q2 and Q3 on the back of the overall stock market.
Shares of SBUX also moved higher in Q3 for the same reason but underperformed DNKN.
As the chart shows, SBUX shares higher from $73.59 at the end of Q2 to $85.58 at the end of Q3, a gain of $11.99 or 16.29% over the three months. SBUX hit an all-time high of $99.72 per share in July 2019. The cost of goods sold for DNKN and SBUX rose in Q3 when it comes to coffee beans, but the stock market rose, which caused the price of both shares to move higher.
At below the $1.1000 per pound level, coffee futures are closer to the bottom than the top of its pricing cycle.
The ICE futures and futures options market is the most direct route for a long position in the coffee market. However, the JO ETN product is an instrument that attempts to replicate the price action in the futures market.
In Q1, cocoa traded in a wide range but fell 11.46%, and it moved another 2.80% lower in Q2. In Q3, cocoa was the best-performing soft commodity as it posted a 16.47% gain. Over the first nine months of 2020, cocoa was only 0.24% higher as the price action over the past three months turned a loss for the year into a marginal gain. As of the close of business on September 30, 2020, nearby ICE cocoa futures were trading at $2546 per ton. Cocoa futures traded in a range of $2115-$2998 per ton in 2020 and closed just below the midpoint of the band after making a new low in Q3 and recovering.
The weekly chart of ICE cocoa futures illustrates that cocoa corrected to a new low for 2020 in Q3 after trading to just shy of the $3000 level in Q1. Cocoa fell as risk-off conditions on the back of the Coronavirus sent the prices of most commodities lower in Q2. In Q3, it made a lower low while many other commodities recovered, but the price eventually followed with a recovery from July through September. Political unrest in the Ivory Coast added volatility to the cocoa market. Cameroon reported lower arrivals to ports than last year, but Indonesian exports were ahead of last year’s pace. The coronavirus in the US is disrupting Halloween, which is weighing on chocolate demand. Meanwhile, a weaker dollar and stronger British pound tend to support the price of cocoa futures.
Cocoa traded to highs of $3,422 per ton in early December 2015 and then fell to lows of $1769 in June 2017. The midpoint of the trading range is $2,595.50 per ton. Cocoa closed Q3 not far from the average price since 2015.
Meanwhile, as Coronavirus impacts Africa, it could cause production and logistical problems and curtail global supplies. So far, Africa has not suffered like the US or Europe, but time will tell if that trend continues if a second wave sweeps across the globe. The rise of the British pound, which closed Q3 at $1.2904 against the US dollar and was 4.09% higher over the past three months, supported cocoa futures since the end of Q2.
Technical support for cocoa futures on the weekly chart is at $2137 per ton. Resistance is at the Q1 2020 peak at $2998 per ton as we move into Q4.
The NIB ETN product does an excellent job replicating the price action in the ICE cocoa futures market, which is the best route for direct investment in the price of the primary ingredient in chocolate other than the futures arena. Cocoa recovered from the lows of the year in Q3 to trade near the midpoint of its multi-year trading range.
Cotton was the worst-performing soft commodity in Q1 as the price fell 25.95%. In Q2, the fiber futures recovered by 19.26%. In Q3, cotton moved 7.89% higher and was 4.72% lower over the first nine months of 2020.
As the weekly chart highlights, in Q2, cotton futures fell to a new low of 48.35 cents per pound, the lowest price since 2009. The price recovered to over the 64 cents per pound level by the end of September. Nearby ICE cotton futures settled on September 30, 2020, at 65.79 cents per pound. Cotton futures traded in a range from 48.35 to 73.08 cents over the first nine months of 2020 and did not trade outside the band in Q3.
Cotton is a highly volatile commodity, and in March 2011, cotton traded up to an all-time high of $2.27 per pound on supply shortages. Following the all-time high, the price moved progressively lower until finding a low at 55.66 cents in March 2016. In Q1 and Q2 2020, the risk-off conditions on the back of Coronavirus took the price below the 2016 low and to a level not seen in eleven years. In Q3, cotton edged consistently higher.
Technical resistance and support levels on the December contract are at 66.93 cents and at 59.51 cents per pound. Cotton was trending higher at the end of Q3.
BAL is the cotton ETN product that suffers from limited liquidity.
Frozen Concentrated Orange Juice Review
Trading FCOJ futures is a frantic business; I would not recommend it to anyone because of the lack of liquidity. The orange juice futures market moved significantly lower in Q3 2020. In Q1 2020, FCOJ futures posted a 23.66% gain making it the leader of the soft commodity sector and when compared to all of the other futures markets in the asset class. In Q2, the bullish party continued as the soft commodity moved 5.91% to the upside. In Q3, FCOJ gave up a lot of its gains as it fell by 10.68% and was the worst-performing soft commodity. Orange juice traded in a range of $0.9120 to a high of $1.3200 per pound during the first nine months of 2020. FCOJ settled on September 30, 2020, at $1.1370 per pound. OJ futures did not move outside of the 2020 range in Q3.
As the weekly chart highlights, FCOJ futures had made lower highs and lower lows since June 2018.
OJ is a thin and illiquid market that is dangerous as it is susceptible to price gaps when the price is moving. The price below the $1 per pound level became unsustainable and had been taking the stairs higher from late February until early June when it turned lower.
As we enter the winter season, the potential for freezes in Florida always has the potential to cause sudden rallies. Meanwhile, the price trend going into Q4 was lower.
Unfortunately, there are no ETF or ETN products in the FCOJ market. The only route for trading is via the ICE futures contract. The average daily volume tends to be well below 1,000 contracts. At the end of September, the volume in the futures market was rising as the price fell. The recent trend was bearish in the OJ market.
The bottom line and a quick look at lumber
Four of the five soft commodity prices moved higher in Q3. Cocoa was the star performer for the quarter. Coffee posted a double-digit percentage gain as the price recovered from the $1 level at the end of Q2. FCOJ was the worst-performing soft commodity as the price was heading back to the $1 per pound level. Sugar was the second-leading performer with an almost 13% increase over the three months. Cotton moved higher since the end of June.
The potential for supply issues is always a danger when it comes to these agricultural commodities markets. The global economic meltdown in Q1 and into Q2 because of the global pandemic could cause supply chain problems as well as production issues when it comes to labor in producing nations. We are likely to see continued price volatility in all markets in Q4, and soft commodities are no exception.
The lumber market posted a significant double-digit percentage loss in Q1, as the price put in a bearish reversal on the quarterly chart on the back of the global pandemic. In Q2 and Q3, the price of wood soared higher. In mid-May 2018, lumber futures traded to a new all-time high when the price reached $659.00 per 1,000 board feet surpassing the February peak at $536.20 and the 1993 previous record high at $493.50. In Q3, the price of wood blew through the record high as a hot knife goes through butter.
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. After reaching a record high at $659 per 1,000 board feet in May 2018, the lumber market plunged and finished 2018 with a 25.78% year-on-year loss. In 2019 lumber moved 21.89%. In Q1 2020, the price fell 31.29%. The price of wood turned around in Q2 and posted a 55.65% gain. In Q3, lumber moved 40.51% to the upside and was 51.05% higher over the first nine months of 2020. The price of nearby lumber futures closed on September 30, 2020, at $612.00 per 1,000 board feet after putting in a new high at $1000 per 1,000 board feet. Over the first nine months of 2020, lumber traded in a wide range from $251.50 to $1.000.00 per 1,000 board feet and closed at the end of September at $612.20.
Lower interest rates in the US typically increase the demand for new home construction, which translates into more demand for wood, which is a critical industrial commodity. Rates have dropped to historic lows, which is a positive sign for the housing market. The demand for wood increased during the quarantine as homeowners increased home improvements. Simultaneously, shutdown and slowdowns at mills limited supplies.
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.
WOOD and CUT are top lumber products that trade on the stock exchange. WY is a company that operates as a real estate investment trust in the lumber market with properties in the US and Canada. WOOD, CUT, and WY shares tend to move higher and lower with the price of lumber. The prices of these instruments fell sharply with the price of wood and the stock market in Q1. In Q2 and Q3, they all moved higher with the price of wood and the performance of the stock market.
Soft commodities prices are some of the most volatile in all of the sectors of the raw materials asset class. These commodities tend to move to the top and bottom ends of their pricing cycles often, and the weather conditions around the world, along with crop diseases and acts of nature can wipe out annual crops in the blink of an eye at times. The virus presents another set of challenges for the agricultural products from production to the supply chain.
The Invesco DB Agriculture product (DBA) includes an over 18% exposure to the three most active soft commodities as it holds positions in sugar, coffee, and cocoa futures contracts. The fund summary for DBA states:
“The investment seeks to track changes, whether positive or negative, in the level of the DBIQ Diversified Agriculture Index Excess Return™ (the “index”) over time, plus the excess, if any, of the sum of the fund’s Treasury Income, Money Market Income and T-Bill ETF Income, over the expenses of the fund. The index, which is comprised of one or more underlying commodities (“index commodities”), is intended to reflect the agricultural sector. The fund pursues its investment objective by investing in a portfolio of exchange-traded futures.”
The most recent top holdings of DBA include:
Source: Yahoo Finance
The soft commodities sector posted a 7.41% gain in Q3 2020.
As the chart of DBA illustrates, it moved from $13.50 at the end of Q2 to $14.74 at the end of Q3 2020, a rise of $1.24 or 9.19%. Price appreciation in some of the other agricultural commodities supported the performance of DBA in Q3.
The one constant in all of these agricultural commodities is that the growing world population continues to underpin prices. As demand rises each year, the world depends on growing supplies. In years where production is abundant, prices do not feel the impact of the rising demand. However, when shortages develop, price action can become explosive. The global pandemic presents new challenges for many members of the sector. Soft commodities can be one of the most volatile sectors of the commodities market, and the price variance often occurs when market participants least expect price moves. Q4 2020 and beyond has the potential to be a volatile time for this sector of the commodities market where prices routinely double, triple, and halve in value because of weather, crop disease, currency moves, and other exogenous factors, such as the current unprecedented environment that impacts all people around the globe. The last global crisis in 2008 led to significant rallies that took prices to peaks in 2011. The stimulus in 2020 is far higher than in 2008.
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.
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