Agricultural Commodities- All Quiet Before the Storm

Commodity prices tend to move together. A bull market in commodity prices began around 2003 and lasted until 2011/2012.  Although each day, week, month and sometimes year commodity prices often do not move in lock step, they did appreciate over this period as an asset class.

Different factors influence certain raw material markets more than others do. For example, China has a great deal of influence on the metals and minerals sectors.

China has been building infrastructure for decades. This has required vast amounts of metals and minerals for projects. Therefore, a slowdown in China over past months has caused the price of many commodities within these sectors to fall. In fact, after 2012 the price of commodities, as an asset class, entered into a bear market. The prices of many commodities have moved lower. When it comes to agricultural commodities, one of the most important factors influencing prices of grains and soft commodities is the weather. The fundamentals for commodities have two components, supply and demand. Supply comes from two sources, production and inventories. Demand is the amount of the commodity needed to satisfy requirements.

Agricultural commodity prices have been in a bear market since 2012. Grains made highs in that year while many soft commodities traded to their apex in 2011. In the years that followed ideal weather conditions exacerbated pressures on the entire asset class.

This meant that crop output exceeded demand and inventories increased. In 2015, the strongest El Nino since 1997 caused the prices of rice and sugar to rise from multi year lows.

When it comes to agricultural commodities, each year is a new adventure. The weather dictates growing conditions and the ultimate crop output.

Additionally, crop disease can cause problems with crop yields. In 2014, leaf rust on coffee trees and plants caused the price of coffee to move higher. In 2015, citrus greening caused the price of frozen concentrated orange juice futures to appreciate from just over $1 per pound to over $1.60 over a short period. As you can see, agriculture is sensitive to weather and crop fungus issues.

Another important factor influencing the price of agricultural commodities is demographics. Population growth has been exponential over recent decades. Over the past fifty years, the population of planet earth has more than doubled. While arable land for growing crops is a finite resource, the number of mouths to feed continues to grow. This means that each year the world relies on more and more agricultural products to feed the masses. In years where there are bumper crops, supplies satisfy the growing demand. However, when crop yields are low, prices move higher as there are not enough grains and soft commodities to meet requirements at low prices. This is an example of classic economic theory. When prices move lower, demand increases and when they move higher the opposite is true as consumers seek cheaper alternatives.

The current year, 2016, is a year that follows three straight years of huge crop yields across most agricultural commodities. The large supplies have caused prices to move to the lowest level in quite some time. However, the only thing certain about the price of these commodities over the course of this year is the uncertainty. Only Mother Nature knows what the weather will be and that is what will ultimately determine crop yields and prices. Therefore, any unexpected droughts, floods, weather events or crop diseases or fungus that decreases crop yields will have a direct effect on prices. There are more people on planet earth to feed in 2016 than there were in 2015 or any year prior for that matter. Grain and soft commodity markets were quietly trading at the lowest prices in many years as 2016 began.

However, it may just be a case of all quiet before the storm when it comes to these agricultural commodities later this year. Even if other commodity prices continue to move lower, in the fifth year of the bear market in the asset class, production levels of key food ingredients will ultimately determine the prices people around the world will have to pay in order to eat.