Macro investors talk confidently about abstract concepts such as intertemporal preferences, inflation expectations, and the liquidity premium. When we move into the more tangible world of commodities, we aren’t as comfortable. In discussing agricultural futures, we often start mumbling like Chauncey Gardner about how “growth has seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.” 1 1 Close Actually a lot of GDP forecasts kind of sound like that too. Coincidentally there is a safety on the Florida Gators named Chauncey Gardner-Johnson. It is true: agricultural commodities are very seasonal. There is a planting season and a harvesting season. Fortunately, there is far more to grain markets.
For much of the past five years, grain markets have not been a popular topic. The charts of corn and soybeans look like zombies wandering aimlessly. There have been a few spikes, but prices generally ended up back where they started. This price behavior is not unusual: in the past century grain markets have experienced many long listless periods followed by spectacular bull and bear markets. The occasional husky price moves can be caused by droughts, crop disease, or other shortages. Grain futures also have long periods in contango, meaning that the carry of holding them is negative. 2 2 Close Some of the historical curve distortions may have to do with price-based government subsidies that have been changed. Still, according to our research, returns on passive holdings have been net positive since 1877, so grains may offer investors a small risk premium. 3 3 Close I know it’s only since 1877 and you want a long history. Steep contango curves have been associated with higher spot returns and a risk premium may come from hedgers. Results based on equal-weighted portfolios of commodity futures for which price data was available at different points in the historical sample. For further detail, please see: Levine, Ooi, Richardson, and Sasseville. 2018. “Commodities for the Long Run,” Financial Analysts Journal. It may be that the big bull markets compensate investors for the negative carry periods. 4 4 Close Or it may be that the carry is inversely correlated with spot prices so convergence comes from spot appreciation.
The macro economy may give some hints as to when big moves may occur. Grains have tended to go up in times of high inflation and low interest rates, both of which are considered good for commodities in general. The relationship between the economy and grain prices, however, is not believed to be as strong as it is in financial futures. Right now, conditions might seem ripe for a rally: the economy has been expanding and in many countries interest rates are barely above zero. On the other hand, inflation is low, which has dampened sentiment on commodities.
The trade dispute with China created some brief excitement in the grain complex last year. In retaliation for the U.S. tariffs on a variety of goods, China slapped a 25% levee on one thing it buys in bulk from the U.S.: soybeans. With exports compromised, U.S. inventories rose to record highs 5 5 Close U.S. Department of Agriculture (USDA). and soybean prices got crushed into meal. 6 6 Close Figuratively. Then, as part of the temporary trade truce in December, China promised to buy some soybeans. 7 7 Close Reuters: “China makes first big U.S. soybean purchase since Trump-Xi truce,” 12/12/18. This planted the seed in investors’ minds that the trade tensions might provide an upside scenario for beans. It seemed, at least for a little while, that China might try to narrow its trade surplus through consumption of U.S. goods. Some investors reasoned that for China to make a meaningful dent in its bilateral trade balance with the U.S., it would have to buy a whole lot of soybeans. Prices recovered some of their losses, but trade negotiations have not played out smoothly. As we stand today, soybean inventories are still very high and trade issues are unresolved. This, however, does not necessarily mean that grain prices are destined for more aimless wandering.
The planting season in both soybeans and corn is about to start. 8 8 Close Some wheat grows over the winter, so its planting seasons are more year-round. It comes after the Midwest experienced one of its most difficult winters in the past century. Rivers in Nebraska, Iowa, and other states have flooded, damaging crop inventories and stranding livestock. 9 9 Close Wall Street Journal: “Floods Deal a New Blow to the Farm Belt,” 3/28/19. It is far too early to tell what the extent of the losses will be or how much of the soil will be suitable for planting. Normally the USDA Prospective Planting report sheds some light on expectations, but this year it is less informative because it was conducted prior to the floods. 10 10 Close Think of everyone gathered around the screens as in Trading Places, except it wouldn’t matter if Beeks had stolen the report because no one cared about the report. The floods are also affecting crop choices. Inventories in corn are not as high relative to history as in soybeans, so it was thought that farmers would switch from planting soybeans to corn. Soybeans have a longer planting window, so if conditions delay seeding, farmers may be forced to grow more beans.
Demand for corn is almost as uncertain as it is for soybeans. Even though it seems like we all eat too much cereal, most corn goes into animal feed and ethanol production. Despite questions about its efficiency as a fuel, ethanol demand had grown steadily until last year when renewable fuel standard waivers for smaller refineries cut into demand. 11 11 Close Reuters: “Biofuels group Growth Energy sues U.S. EPA over small refinery exemptions,” 2/4/19. This year may bring more demand, and with new ethanol requirements in China in 2020, there is potential for higher exports if the trade talks end favorably. 12 12 Close China has stockpiled plenty of corn because of past subsidies, but there is a lack of refining capacity for certain types of ethanol. The kinds that they have mandated be used. The floods have disrupted the ethanol supply chain, and at least one major processor was temporarily taken out of service. 13 13 Close Bloomberg: “Floods Threaten to Cause Ethanol Disruptions and Higher Pump Prices,” 3/28/19. This may result in working off some excess inventory. As far as feed, we still don’t know how much livestock has been lost to the floods and probably won’t for a few weeks.
None of this necessarily means that there will be more volatility, but it creates real uncertainty about supply and demand. All markets, including commodities, have difficulty processing this type of uncertainty. Grain prices have barely reacted. In a sense the floods are like Brexit in that they create the potential for big moves but also for status quo. The major difference is that the floods are a natural disaster and the farmers affected are handling it responsibly and doing the best they can considering the situation. For investors, information will come in slowly on planting and crop losses. Watching these markets might give macro folks a nice break from staring at the yield curve and news about Europe and a good excuse to mumble meaningless platitudes. As if we need an excuse.
What We Are Watching
Manufacturing Surveys in U.S., China, and Japan (Monday)
Recent signs of slower global growth have been particularly evident in manufacturing data. On Monday, we will see updated readings on four of the most high profile manufacturing surveys: the ISM Manufacturing PMI in the U.S., the Caixin and CFLP Manufacturing PMIs in China, and the Bank of Japan’s quarterly Tankan survey. All four indicators have declined meaningfully over the last year, although both the ISM and the Tankan remain at reasonably healthy levels by historical standards. Preliminary March PMIs published last week in the eurozone were surprisingly soft, fueling concerns that global industrial activity has continued to worsen. If this week’s data shows continued deterioration in other large economies, it could add to fears around the outlook for the global economy.
U.S. Retail Sales (Monday) and Durable Goods Orders (Tuesday)
Monthly data on retail sales and durable goods orders will provide an update on spending by consumers and businesses respectively. Retail sales declined sharply in December, triggering fears that the U.S. consumer was pulling back. While spending staged a partial rebound in January, another strong reading in February (and perhaps some upward revisions to prior months) would help provide reassurance that consumption has not stalled. Delays to tax refunds, which typically provide a boost to household incomes at this time of year, might pose an additional headwind to the February sales figures. With respect to durable goods, market participants tend to watch so-called “core” capital goods shipments, 14 14 Close Excluding volatile orders in the defense and aerospace sectors. which track capex spending by firms. Demand for these goods rose in January after experiencing large declines in the prior two months, but the trend in growth seems to have slowed. With continued concerns around global growth, February data for durable goods orders will shed light on the extent to which U.S. businesses are reining in their investment plans.
U.S. Employment Report (Friday)
March nonfarm payrolls will be released next week after a surprisingly low job count was reported for February. The U.S. economy added only 20k jobs that month, the slowest payroll gain since September 2017. Nonetheless, average job growth over the last three or six months continues to suggest a healthy pace of hiring in the U.S. Notably, some of the weaker industries in the February report appear to be particularly sensitive to weather effects or winter seasonal factors (for example, construction). This raises the possibility that the surprisingly small net hiring was only a temporary blip. While the job count came in below expectations, income data surprised to the upside. Wages rose more rapidly than expected, reaching a new cycle high of 3.4% year-over-year. Wage dynamics appear consistent with the broad-based strength of the labor market and an unemployment rate that has remained below the Fed’s estimate of NAIRU for more than a year.