Materials Risk

It’s almost school holiday’s here in the UK. It that time of the year when families typically drive to the airport, to their next Airbnb, to the campsite. Anything to get away from the typical British summertime (this year has been especially dreary). Almost always it involves spending more time than you have done all year with your family, in a confined space for hours, being distracted by “How much further?”, complaints about your driving all the while having to focus on the road ahead of you for several hours I’m lucky(!) enough to be counting myself among that group over the next few weeks.

In preparing for my journey I happened across an article about being a better driver during the holidays. Two suggestions in particular struck me as important lessons; to always look further ahead, and to always think about your own journey as personal to you.

Being able to anticipate the speed of other cars further down the road, the actions of pedestrians and the conditions of the road should help you be a better driver. In essence its about being able to give yourself enough time to react to events. The more you practice, the greater your experience, the more likely (at least in theory) that you will avoid any trouble.

Meanwhile, always thinking about your own journey as personal to you means that you don’t react negatively to the behaviour of others on the road, while also becoming more proactive and compassionate in how you interact with other road users.

What does this all have to do with investing and trading commodity markets? First its about looking ahead, looking for the signs that things may be about to turn, that sentiment is too extreme and that investors may be about to run for the exits. In commodity markets this can take the form of extreme market positioning in futures markets, commodity producer sentiment (supply discipline for example) and seasonal demand and supply trends.

Second, whatever your outlook, whatever your trading or investing style its important to always consider that your own journey. That goes for your own level of risk, the instruments you trade, what time period you are considering, what your hopes and dreams are. Its your commodity market play book, no one else’s.

It’s always been challenging balancing your own objectives versus the fear of missing out, comparing yourself to others and then overly reacting. It’s now much harder to sift through what is important to your journey, and what is not. Someone’s tweet about their view on gold may run counter to your own, but they may have a completely different time frame to yours. Their concerns may just represent a mere footnote in years to come on your investment journey.

The danger (to return to the driving analogy) is that you get caught up in someones else’s race, someone who has a completely different destination to you, an alternative set of time constraints with completely contrasting priorities to you. We’re all on the same road, but we’re all on very different journeys. As it is with our highways and byways, as it is in the markets, keep a watchful eye on others but never let them dictate how you should respond to events. As with driving, as it is with investing always have your end destination in mind.

According to the Chinese Zodiac, 2019 is the Year of the Pig. This year has certainly lived up to its name. The discovery and subsequent outbreaks of the African Swine Fever (ASF) virus in China in August 2018 sent shockwaves through the hog market. ASF is a highly contagious virus that ravages hog herds and currently has no cure.

The price of US hog futures surged by 67% during March-April as the scale of the potential losses became clearer. Since then though prices have retraced 50% of the earlier spike higher, falling back to around 70 cents per lb.

In the past week estimates provided to Reuters have suggested that as many as half of China’s breeding pigs have either died from the disease or have been slaughtered because of the spreading disease, much higher than previously thought. Despite this the markets reaction has been muted.

The problem for hog futures is that the US market is fundamentally oversupplied. The US hog herd is at its highest level since 1943. American producers had been building up their herds in anticipation of increased demand from China. The US-China trade war has muted that response, but there are signs that things could improve.

Meanwhile, China’s pork prices had been kept under control through a combination of releasing stock from its frozen pork reserve (much like the US has Strategic Petroleum Reserve, China has one for pork), and secondly farmers sending pigs to be culled early, especially if the disease was discovered on a local farm. As frozen stocks run low and with no more room for more supply then prices have started to rise. China’s agricultural ministry has said prices could surge by 70% in coming months as a result of the outbreak.

China’s imports of pork and swine offal from the US in May jumped to the highest in at least a year, exceeding the level before Beijing’s hefty 62% retaliatory tariffs were imposed in July last year. China’s total meat imports also hit a record in May as looming meat shortages drove up domestic prices. Nevertheless, tariffs are likely to mean that other hog producing regions like Europe and Brazil are likely to benefit most from Chinese import demand.

Instead, the US hog market may also see strong export support from other countries affected by ASF. Outbreaks of the disease have been detected in parts of Southeast Asia, Japan, Poland and Russia. According to Capital Economics pork represents around 2% of the consumer price index basket in many of these countries (vs 3.5% in China and 1% in most other emerging economies).

The longer term hog chart offers some useful insights as to the upside potential. Overall, it suggests that unless ASF (or another disease) spreads to the US, Europe or Brazil then it is very unlikely that prices will go much above current levels, at least not for any sustained period. Apart from a few very brief periods over the past two decades the price of hog futures has typically bounced between 50 and 90 cents per lb. Seasonal demand and supply fluctuations typically resulting in higher prices in the spring/summer and lower prices in the autumn. The only time hog futures have been outside of this range for a significant period was in 2014 when disease struck. Back then the PED virus decimated the pig herd causing prices to hit a record high just over 130 cents per lb in July 2014.

Another factor likely to limit any future upside price response is the substitution effect. Recent statistics from Shandong, China’s largest feed producing province show that farmers have indeed cut back on hog production, but the drop in output has been offset by an increase in poultry output. China’s poultry consumption has increased in recent years, as demographic changes, growing wealth and urbanisation contributing towards the trend. Indeed, the outbreak of ASF may accelerate these longer term trends. According to a recent report from Mizuho the nation’s consumers “aren’t discriminating between a disease that only affects the hog and what can be transmitted to humans,” turning them off from wanting to eat pork and reducing consumption.

Related article: Livestock prices: The top 10 most important drivers

Digesting the financial media’s latest headlines at the wrong time of day can be bad for your personal and financial health. Headlines can, when you can think about them rationally offer important clues into the state of financial markets, opening up opportunities for investors. According to Peter Atwater, President at Financial Insyghts:

“The morning headlines in the Wall Street Journal, the Financial Times the New York Times, the Washington Post… are huge mirrors. They are telling us how we feel and what we believe to be true.”

The front page of a newspaper or the opening items on the TV news broadcast are only ever things that confirm what we already believe to be true. After all, the media are trying to move us onto page 2 and so on, and to stick around for the next item on the TV news bulletin. According to Atwater trends are “over-believed” by investors, those that can be easily extrapolated long into the future are the most dangerous for investors:

“When everyone believes something is going higher, like interest rates last fall, the opposite is likely. As I write often, extrapolation kills.  And the bigger the trend-extrapolating headline and the more prominent the headline’s position, the more likely a reversal is. Typically, when something makes it to front page coverage, the end is near.”

With that in mind what do recent headlines say about the state of commodity markets?

“The migration problem is a coffee problem” – Washington Post

People don’t abandon their livelihoods, homes and ancestral homelands unless they can’t see the situation getting any better. For farmers in Guatemala that point appears to have been reached over the past year. The country is the largest single source of migrants to the US with numbers doubling over the past year to over 200,000. For coffee farmers there and elsewhere in South America the decline in coffee prices has been relentless and crushing; from a high of around 300 cents per lb in 2011 coffee futures fell to below 100 cents per lb in 2019. Coffee prices are under pressure due to an increase in mechanized production in Brazil (the largest producer), and higher output from Honduras, Vietnam and Colombia. The negative roll yield has been a boon for those short selling the futures contract.

Related article: Coffee prices: The top 10 most important drivers

‘The future is nickel’: Cobalt 27 sells off its namesake metal after tough year – Financial Post

Toronto based Cobalt 27 stockpiled cobalt and streamed mining rights in a bid to ride the wave of growth from the metals use in electric vehicle batteries. Over the past year the price of cobalt and the share price of Cobalt 27 has fallen by around two-thirds. Higher than expected output from the DRC and a slowdown in demand from China as auto sales ground to a halt were behind the fall. Yet like rhodium a decade ago, arguably sentiment towards cobalt was too high in the first place. Buying high and selling low doesn’t inspire confidence. Sentiment is so low that the company is selling off its cobalt holdings to focus on nickel instead.

Related article: What lessons does rhodium have for commodity investors?

‘It can’t get any worse’: Iowa farmers suffer as U.S. trade war with China escalates – Des Moines Register

Farmers have perhaps had it too good for too long. Strong growing conditions for several years and strong demand from China and emerging economies helped support US agriculture. Slumping agricultural commodity prices, trade wars and poor weather have battered US farmers. As with all the examples in this article sentiment could get worse before it gets better. But when the media start reporting that things can’t get any better, that there is no end in sight to the suffering that often sets the scene for a rebound in sentiment.