The bust of agricultural commodities over the past couple of years has brought down the cost of betting on the world’s growing need for food and clothing.
Since the recession, the so-called soft commodities have been influenced by much more than supply and demand. Fuelled by speculative trading, prices of food and cotton hit extremes, peaking in 2011 before dropping off almost across the board.
But fundamentally, not all that much has changed the outlook for commodities like coffee, cocoa, sugar and cotton.
“We’re looking at a pretty interesting environment for making initial long-term bets on soft commodities,” said Shawn Hackett, president of Hackett Financial Advisors in Boynton Beach, Fla.
Investment support for soft commodities relied on two popular expectations. The first is that unprecedented monetary stimulus would result in inflation. Commodities both hard and soft became popular as inflation hedges as a result.
But those inflationary pressures never came to be, shaking the first “pillar” supporting soft commodities, Mr. Hackett said. “The second pillar is the idea that Asia, specifically China, is going to continue to grow and consume everything in sight.”
That pillar, too, has weakened, as emerging market economies have stumbled.
Soft commodities plunged as a result. Futures contracts for coffee recently hit a four-year low, down 60 per cent since the April, 2011, peak. Sugar futures are down 20 per cent off of last year’s high. Cotton has also dropped by 20 per cent.
“We might have just reverted to the mean,” said Ron Lawson, a partner at commodity investment firm LOGIC Advisors. “And in fact, we’re still probably above the mean.” Such was the extent of the price run.
The fundamentals were in place for a more modest rally, Mr. Lawson said. But investors fleeing inflation and hunting for returns amplified the trend.
“That was driven by vast amounts of liquidity with no place to be invested. Everybody was looking for something to put their money into,” he said. “There’s never been this kind of money flow into commodities.”
Prices soared, triggering a second overreaction.
“A lot of producers were hoping to see the growth we had in 2008 to 2010, and they planted crops with those expectations,” said Timothy Evans, chief market strategist at Long Leaf Trading Group.
The resulting supply glut in many of those commodities finally put a cap on the rally and sparked the correction now playing out.
While the rise and fall in soft commodities may have been exaggerated, support remains for a long-term run. In the United States, quantitative easing continues apace at $85-billion (U.S.) a month, which could eventually bring out the long-anticipated inflationary pressures. And the food requirements of the emerging world are still growing.
“China’s having an increasingly difficult time feeding itself,” Mr. Lawson said. The rise of the Chinese middle class, with an ever-growing appetite for Western food habits, should prove a solid foundation for agricultural commodities.
The correction may yet have room to slide, but investors might see long-term value in soft commodities at current prices. “If one’s not a trader, but has a longer-term view, this is an interesting place to start taking some stabs on weakness,” Mr. Hackett said.
Coffee is his top pick in the sector. “The surpluses in the upcoming crop cycle are well priced in and that will be the last of it. And demand for coffee is growing like crazy.”
That growth could become explosive if China truly becomes a coffee-drinking country.
There are ETFs available for each individual commodity, or investors can bet on a bundle of soft commodities through the iPath Dow Jones-UBS Agriculture Sub-Index Total Return ETN.
But those who put money into the area should be aware of the perils of soft commodities, which are more thinly traded and volatile than metals or energy commodities. Plus, one must account for the effect of speculative traders, Mr. Lawson said. “The effects, especially to the upside, are going to be magnified.”