Competing supply/demand fundamentals make commodities sector to watch in 2014

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Commodities are off to a wild start this year with extreme weather around the world playing a big part. Natural gas is leading the pack, up 30% off its January lows on a long stretch of extremely cold temperatures across the Midwest and East Coast. Drought conditions in Brazil and California have sent coffee, sugar and cattle prices racing higher. Coffee is up 62%, its highest level since October 2012. Over the past three weeks, sugar is up 13%. Cattle is trading at record highs, up 7.5% over the past three and a half months.

What makes trading commodities challenging is that fundamental and seasonal factors differ a great deal depending on the underlying. The challenge is to stay on top of all the key drivers affecting the markets. As tensions in the Ukraine reach new heights, market participants are once again reminded that no man or market is an island, with the Ukrainian unrest perhaps starting to be priced into the wheat and corn markets. The energy markets serve as another example of geopolitical tensions affecting commodity prices, with a certain fear premium always priced into those particular markets due to the ongoing tensions in the Middle East.

There has been a great deal of recent talk about the huge increases in U.S. crude oil and natural gas production and how that is affecting the world supply and demand picture. What has been surprising to some is that, for now, prices have largely remained steady and even increased at times. Take the recent spike in natural gas: a 43% increase over the past four months is causing a great deal of pain on the street. While this may seem counterintuitive, it can be explained by the extreme winter conditions affecting large parts of the United States, logistical issues stemming from where that new production is growing and infrastructure that needs updating.

On the Crude front, we have become far less reliant on imports, with levels dropping from some 60% to 30%. In spite of this, prices have remained relatively steady, with world demand matching any increases in production. The dynamics of this are playing out in the WTI vs. Brent spread, with Brent giving back a big chunk of the premium that it had over WTI. Expectations are for the two to continue to converge. 

The Metals complex has also seen big moves since the beginning of the year with Silver up 12% and Gold up 10%. With silver trading just under $22 per ounce on Friday, the commodity may be becoming more attractive to producers who were struggling to cover costs of production when the metal was oscillating between $18 and $20. Economists continue to watch copper closely as it serves as a key indicator of economic strength. Is the sideways movement in Copper over the last nine months trying to tell us something? Interestingly, other industrial metals, including platinum and palladium, are telling a similar story with largely range-bound trade.

Grain planting season is fast approaching, intensifying speculation about how many acres will be planted in the upcoming season and the effects of the stark weather discrepancies that we are seeing across the country and world. While the planting season is always an adventure, there is reason to believe that, as with the energy markets, world demand for key agricultural commodities continues to grow.

Soft commodities have also been seeing some wild moves. Coffee, seemingly stuck in a bearish trend for the past three years, recently took off to the upside in reaction to severe droughts in Brazil. Will the effects be long lasting? Also being affected by the dry Brazilian weather, sugar is mirroring the recent bullish moves of coffee, rallying sharply since late January.

Looking at commodities as a whole, the CRB Index and RICI Index show that we have been following a bearish trend since September of 2012. This changed in January of this year when both indexes made a sharp turn to the upside, reflecting improved demand expectations and better economic conditions. The CRB Index is up roughly 10% and the RICI Index 6% (see chart).

 

 Since September 2012, the CRB Index (white) and RICI Index (orange) generally have been following a bearish trend line. This changed in January of this year when both indexes made a sharp turn to the upside, reflecting improved demand expectations and better economic conditions.

 

About the Author
Greg Adamsick

 

Greg Adamsick, Vice President of Global Futures & Options at RCM Asset Management, helps clients seize opportunities in the futures and options markets and satisfy portfolio needs. His passion for the markets was born on the CBOT and CME trading floors over 20 years ago. Relying on a combination of technical and fundamental indicators, Greg has developed a unique global macro perspective that helps him identify points of change in the markets. Greg Adamsick can be reached at gadamsick@rcmam.com.      

 

TRADING FUTURES, OPTIONS ON FUTURES AND RETAIL OFF-EXCHANGE FOREIGN CURRENCY TRANSACTIONS INVOLVES SUBSTANTIAL RISK OF LOSS AND IS NOT SUITABLE FOR ALL INVESTORS. YOU SHOULD CAREFULLY CONSIDER WHETHER TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES, KNOWLEDGE AND FINANCIAL RESOURCES. YOU MAY LOSE ALL OR MORE THAN YOUR INITIAL INVESTMENT. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.


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