The soft commodities were held under pressure last year by recent flare-ups of the trade war. However, some goods started the year with a surprisingly strong rally this year. Climate change and the global economic cycle are slowly but surely stabilising prices.
The World Bank’s analysis of the commodity market, which does not encompass energy and metals, tries to do the impossible from quarter to quarter. Soft commodities are moving according to hard-to-define trends, it is difficult to find common among the factors that control the exchange rates of cocoa, palm oil, milk and Chinese pork, as well as soybeans or orange juice.
In the case of crops, the trade war and the duties imposed dictate since many quarters of the conditions. According to the World Bank, the decline, which has generally characterised price levels in 2020, will continue to be with us, but some stabilisation can be expected. Factors that contributed to the previous fall continue to play an important role, such as accumulated rice and wheat stocks at a multi-year high. The World Bank also mentions the price-reducing effect of favourable weather conditions in certain regions. The good harvest in these places has increased supply, but in the absence of demand, only stocks were increasing, not instant sales.
Although minor progress has been made in resolving trade disputes on several continents, customs duties remained with us in 2020. Nor has it changed that energy costs are still low and commodity demand has not shown a significant increase so far. The World Bank’s agricultural price index fell about five percent last year and the growth outlook for 2020 was revised downwards in October.
They can see the end of the tunnel now…
The reduction in trade war pressures, according to the World Bank, could mainly increase the price of soy and maize, while cheap petrol and diesel and non-expensive fertilizers tend to reduce the cost of intensive energy intensive crops such as oil seeds. The exchange rate of such crops and plants is not expected to increase. At the same time, the expected one percent reduction in energy costs this year may be negligible compared to the 15 percent fall in 2019. The World Bank does not expect a breakthrough change because, in their experience, a 10 percent change in energy prices will result in only a two percent shift in the grain and oil seeds course ceteris paribus.
The short-term effects of the trade war are with us clearly, but now longer-term trends have also begun to change. For example, American farmers are increasingly throwing less soy than Brazilians, who have now increased the proportion of soy-producing areas due to tariffs that benefit them.
Several markets for substitute products are booming. Chinese importers have replaced the expensive soy bean oil with palm oil and the soy bean used as animal feed is replaced by other competing products in areas affected by customs duties. The strength of the US dollar has had a negative impact on US domestic producers, after the USD having strengthened nearly 15 percent in the last 20 months against major currency basket. In some local markets, such as coffee, foreign exchange changes were the real inputs for commodity prices, for example the Brazil real’s volatility caused many swings in the coffee prices.
It is worth treating separately the tea and coffee market, because they are clearly deviating from the trends in other soft commodity products in the world. For example, the price of refreshing drinks has been able to show a significant increase since the beginning of 2019, mainly due to the soaring of Arabica coffee. Similarly, the market for cocoa defined by some operators should be an exception.
In the World Bank’s material, it draws attention to the fact that the changing climate will increase the frequency of weather anomalies with sudden crop loss. Storms, severe floods or drought-stricken periods will affect the quantity and quality of the crop more often and unpredictable. Last spring, for example, some 19.4 million hectares remained undeployed in U.S. soil due to floods and rainfall. In addition, an additional 14 million hectares of soybean, corn and wheat areas remained empty, causing a one-off rate spike on the stock exchange.
The benchmark has now become soybeans
If you don’t want to read daily political news about the trade war, it’s enough to look at the price of soybeans, which copies every little shake. ING’s annual commodity market preview claims that the loud political strife has left the changes in demand and supply completely out of the picture. However, Chinese demand appears to be increasing in 2020 as a result of various economic stimulus program. African swine fever may have already peaked in the Far East,-at least according to local operators-, but the pork price remained at its historical maximum. This anomaly may encourage farmers to start holding pigs again, so that demand and imports of soybeans can increase as early as 2020, regardless of the outcome of new trade war negotiations.
Soybean prices could also rise this year because many U.S. producers have switched to corn, with the USDA calculating a fall of almost 15 percent this year on soybean plantations. The crop will also be negatively affected by the rainy planting period. The longer trade uncertainty persists, the more impact it has on deployment strategic decisions.
Of course, they’re not just producing soy in the United States, the South American region is taking advantage and it broke records last year. Brazil was able to benefit from the trade war primarily because the Argentine domestic political changes brought Alberto Fernandez to power. The new Argentine government, led by Fernandez, could raise the export tax on agricultural products and already created uncertainty among producers.
Less sugar
This year started with a strong rally in the sugar price. India and Brazil play a decisive role in sugar. In Brazil, accumulated stocks were significant at the end of the year, covering 55 percent of annual domestic consumption. In the case of sugar cane, the question is always how the ethanol/sugar ratio develops, which product is more worth to produce, since Brazilian plants can change production from sugar to ethanol and back at any time. The decision is determined by the local currency, the Brazilian real as well. According to ING analysts, if the Brazilian real continues to weaken, it could lead to a fall in sugar prices, but this is not what they expect this year. In their view, India’s accumulated stocks will run out quickly and rising prices will lead more and more producers to produce sugar instead of ethanol. However, it is clear that this shift will stop the sugar rally after a while.
The exotic crops rally is fueled by speculation
The example of coffee shows that the appetite for yield does not spare commodity markets. We see such a yield-hunting rally in metals like palladium and rhodium. The new star of agricultural products has become the Arabica coffee, which has risen by 30 percent in days due to the sudden closure of short positions.
That’s exactly how yield seekers found cocoa. After an agreement between Ghana and Côte d’Ivoire companies, it is not possible to trade the raw material for chocolate at a price of less than $2,600 per tonne. This, combined with the fact that international organisations expect a deficit compared to previous forecasts, created a trading opportunity. Now the future adepends on whether the established Côte d’Ivoire’s production ceilings will be respected in the region or whether this measure will increase cocoa bean smuggling from Ghana. The fact that the number of speculative positions in cocoa in London is approaching a possible maximum limit shows that commodity market developments have long been determined not only by economic cycles and demand-supply conditions or weather anomalies, but also vastly by speculative appetite.
Sources:
https://www.worldbank.org/en/research/commodity-markets
https://think.ing.com/articles/2020-fx-outlook-diamonds-in-the-rough/
In addition, a spectacular infographic from VisualCapitalist:
This article was originally published in the January 17 issue of the Hungarian printed economic daily, Vilaggazdasag
