- Historically, the commodity complex was viewed as the Wild West of trading, where long-term positions might last a matter of minutes.
- In reality, the complex has changed as algorithms have taken over from pit traders, with more emphasis on long-term technical and fundamental reads.
- Given many key commodity markets can be viewed as weather derivatives, and the world needs food, energy, etc., long-term investors are taking a new look at the complex.
Last weekend I read a piece on Barron’s website written by Jack Hough. Mr. Hough talked about how complicated it would be to own and run a commodity fund, due in large part to understanding all the fundamentals that come into play (his example being needing “night classes in metallurgical engineering and daily NATO briefings just to form an opinion on zinc”). I understand, as it goes back to something another long-time investor, Peter Lynch, used to always talk about, “Trade what you know”. I’ve said it before and I’ll say it again, if I had a commodity fund it would focus on corn, for the same reason.
While I agreed with some of what Mr. Hough wrote, I obviously disagreed with this idea: “Commodities, on the other hand, only appear simple: bushels of corn, bars of gold, barrels of oil (interesting he would mention the 3 Kings of Commodities), all just moving from here to there, with no one in charge. But that’s what makes them complicated. There are no durable competitive advantages – just price swings. Short term, it’s up to me to judge the endless factors that affect supply and demand. Long term, why bother?”
I number of years ago I was visiting with one of the lead stock analysts/reporters on CNBC, and he mentioned his concern over the “commoditization” of stock markets. Equities had become nothing but short-term gambling chips while long-term investors were taking a harder look at commodities. Even recently we’ve seen the rise of meme stocks due in large part to social media. As we know by now, the rise of social media has worked to lower the average attention span meaning equities could still be viewed as a commodity.
But what about real commodities like gold, crude oil, and corn? A look at charts, both price charts (whatever form one chooses to study) and forward curves (how the prices of contracts within a commodity relate to each other) and we can see the complex has been moving toward long-term trends over the years. Some of this is due to the death of pit trade, where a long-term position might’ve been a matter of minutes, with attention turning to long-term supply and demand issues.
Recall from previous discussions production ag markets are really weather derivatives at heart. Recently we’ve seen a 3-year (at least) La Nina that had a dramatic effect on global grain, oilseed, and softs production, the latter sector (softs; cotton, cocoa, coffee, sugar, orange juice) playing out like a relay as first one market rallies to a new all-time high, only to hand the baton to the next market and so on. The latest to do so is May orange juice (OJK23) as it hit an April high of $2.8750 (per pound), the futures market’s highest price on record. Yes, Mr. Hough is correct with the idea of hundreds of fundamental factors that could be evaluated in orange juice alone, but the reality is we don’t need to know all of them. All we do need to know is the market’s forward curve has been inverted (backwardated) for at least the last six months. On the other hand, the futures market indicated a new uptrend on its long-term monthly chart at the close of May 2019.
In other words, the orange juice market has been consistently trending up for the past 4 years on bullish, weather-related fundamentals and increased long-term interest from investment traders. Can we say the same thing about equity markets? As you know, the long-term trends of the 3 major US markets turned down in January 2022 before bottoming out last October. Along the way there has been “just price swings”, many of which defied explanation.
I’ve had this discussion with financial advisors countless times over the decades. Should commodities be included in a well-rounded investment plan? Nearly all of them follow the lead of Mr. Warren Buffett and say “no”. But if we understand the root role of weather and can read a forward curve chart it only makes sense to have some long-term money in commodities without knowing all the particulars for each market. After all, everyone in the world needs food and some form of energy, and there is almost always something or someone disrupting global supply and demand somewhere.
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
