Commodities are always in the news, but there has been a noticeable increase in the frequency of reports over the past two years. This is in tandem with the anxiety or excitement experienced by market players keeping tabs on this vast sector.
The fighting between Ukraine and Russia has only added more volatility to the global agriculture and energy markets, says Avtar Sandu, senior commodities manager at Phillip Nova. He deems this a “game changing event”, as both countries are major commodities exporters.
Different types of commodities have been taking turns to hog the limelight — and for savvy investors, this has created trading opportunities.
For one, gold, the traditional safe haven asset, for one, surged to new highs at the onset of the fighting. Comex gold futures rose almost 12% in a span of six weeks to above US$2,000 an ounce but later fell back to the present level, as investors found that selling treasury notes and bonds was a more lucrative bet as central banks started hinting at tightening financial conditions, says Sandu.
Into the final quarter of the year, food prices will come into focus, says Sandu in a September interview. The harvest of corn, wheat and soybean in the US have fallen short from previous years, according to the US Department of Agriculture. “The growing crops have not progressed as expected.”
He predicts rising food prices will replace crude oil as a talking point, as the price crunch eases in the months ahead. “From a commodity that had made a great rally, crude oil has become a sell strategy instead of buying the dips,” he says.
See also: Oil extends rally as OPEC cuts output, Russia mulls reduction
And of course, there’s oil. In a bid to lift recession-spooked prices, the Organization of the Petroleum Exporting Countries and its allies (OPEC+) announced on Sept 5 that it will cut oil production for the first time in over a year.
“We feel that with central banks around the world aggressively increasing interest rates, which would lead to demand destruction, even OPEC+ additional crude production cuts may not be effective in propping up prices,” adds Sandu.
After peaking above US$110 per barrel in June, crude oil has since been moving lower, selling off sharply with the WTI crude plunging to an eight-month low.
See also: Investing in oil amid OPEC+ output cut and ESG concerns
As interest rates have risen sharply higher, the energy markets are worried about a global recession, says Sandu. “The slump in global equity markets lately has curbed confidence in the economic outlook and the buzzwords now are either a hard landing or a recession.”
Watch thermal coal, fertiliser prices
Like crude oil, palm oil prices are also expected to be dragged lower amid recession fears, and prices may retrace as much as 30% by the end of the quarter, says Sandu, as ample supply and export competition drive prices lower on weak fundamentals.
Indonesia has contributed more uncertainty for crude palm oil (CPO) this year than the Russia-Ukraine war.
The export policies of the world’s largest CPO producer drove prices to a historical peak in March. “This rally was driven by unexpected and frequent changes in Indonesian export policies, some virtually overnight that often sent chills down traders’ spines,” says Sandu. “These policies soon resulted in an overflow of inventories, plummeting the price of CPO so rapidly that it resulted in the Indonesian government removing export levies.”
However, not all commodities are equally affected by crude oil price movements, says Sandu, and barring unknown tail-end risk events, not all commodities would continue retracing this quarter. “Investors would be watching how Europe copes with the lack of Russian gas amid a European Central Bank bent on curbing inflation and pulling back on quantitative easing.”
As winter approaches the northern hemisphere, Sandu expects thermal coal prices to remain elevated as consumers keep their heaters on. “Natural gas prices may also not follow the onward spiral lead of crude oil this winter as Europeans scramble for whatever gas they can find to keep themselves warm in the approaching winter.”
See also: Futures and options for young retail investors beyond plain stocks
With crude oil prices retracing, non-energy and agricultural commodities would also retrace from recent highs, says Sandu. This is due to lower fertiliser prices and moderating inflation in the face of rising interest rates and demand destruction, he adds.
Fertiliser prices peaked in April following Russia’s invasion of Ukraine. Since then, prices have dropped almost 20%.
That said, the drought in Europe and wet weather in the Indian subcontinent have decimated food crops there. These could drive up prices for wheat and rice, along with other cereals, says Sandu. “India has banned the export of wheat, an event which has driven the price of Chicago December [2022] wheat up from US$7.50 to US$9 a bushel in a span of a month.”
Compared to energy, Moody’s believes there will be less volatility in global agricultural markets. “This is because the supply side is in better shape following larger harvests in Brazil and Argentina and a better growing season taking shape in Australia,” said Moody’s analysts in a Sept 8 webinar. “This will offset the impact of droughts in North America, Europe and parts of Asia.”
Moody’s forecast of declining food prices assumes that Russia’s agreement to export Ukrainian crops will hold. “But this could buckle if hostilities spread to Black Sea ports currently controlled by Russia or if control over key exporting regions is contested. This would be a catalyst for large price spikes and a full-fledged global food crisis.”
Agriculture as an asset class
Corn and soybeans, from which soybean oil is obtained, are two of the most important agricultural commodities used in the global economy, says Sandu. CPO is also increasingly being sought after, as these commodities are used as feedstock, biofuels, cooking oils and even in cosmetics and soaps.
According to Sandu, demand for these commodities has been growing over the years as the global middle class swells, particularly in India and China.
As an investment vehicle, agricultural commodities have often behaved differently from other asset classes as they may be driven by fundamentals that do not affect equities or bonds, says Sandu. They could thus help diversify investment portfolios.
Since the turn of the century, agricultural commodities contracts have been increasingly used as an asset class. “Investors, such as hedge funds, pay attention to themes like the commodity supercycle, the global energy shock, the electric vehicle (EV) revolution and global food crises. Commodities have been considered a sensible investment alternative during periods of inflation and uncertainty,” adds Sandu.
To invest in agricultural commodities, should investors buy exposure via stocks, or via futures and options contracts?
It is a difficult choice, says Sandu, as both choices have their pros and cons. “Quite a bit depends on the sophistication, experience and risk profile of an investor.”
While risk-taking investors can target individual stocks to gain exposure to the agricultural commodity markets, agricultural futures and options offer many benefits like liquidity and price transparency to market participants, says Sandu. “Agricultural markets also quickly and efficiently determine a ‘fair’ price virtually round the clock.”
Futures traders can also employ various strategies like spreads to hedge or speculate on their view of the market, says Sandu. “Exchanges like CME provide a wide array of liquid agricultural options products that offer flexibility for effective risk management, as well as a multitude of trading opportunities.”
“These include a diverse selection of futures and options on grains and oilseeds as well as cost-effective, short-term alternatives like weekly options,” he adds.
