A Bushel of Reality for the 'Commodity Supercycle'

Inflation talk is all the rage. But we haven't seen true, long-lasting, inflation for decades. While it is obvious commodity prices are on a run, it is far less obvious they will stick. In fact, they seldom do because producers, and even end-users, adjust their behavior to alleviate the supply or demand issue causing the price squeeze. It is fair to say that sawmills and farmers will be going into overdrive to capitalize on what could be a once in a lifetime price opportunity. Supply is coming, it is just a matter of when not if. Corn Futures Once every four-to-six years, the price of corn lands on the radar of mainstream media. Not surprisingly, the attention generally comes when prices are amid a dramatic upswing and successfully lures rookie trading dollars into the market. The stories are usually accompanied by terms such as food inflation, drought, and supply crunch. Ironically, by the time the narrative goes mainstream, the market has often priced in the worst-case scenario. That said, there are no reasonable limits to parabolic rallies; even if we are witnessing the topping process in the grain markets, nothing is stopping the momentum from taking prices another dollar or two higher per bushel. Still, history hasn't been kind to HOFDL positions in the agricultural markets. In other words, the diamond hands that worked for some in GameStop stock and cryptocurrencies, likely won't work in corn and soybeans. To be fair, we completely underestimated the enormity of the ag rally. When corn was near $3.00, we were confident $4.00 to $5.00 would be seen, but we wouldn't have believed we would see a $7.50 print in the front-month contract. We were obviously wrong, as were many others. For those that are new to commodities, perhaps introduced by the commodity supercycle stories circulating, $5.00-plus corn has only been seen on two occasions in the last 20 years. Both ventures eventually ended poorly but the volatility was stunning. Source: QST Some might recall the spring and summer of 2020 in which crude oil prices dipped below $10 per barrel and even fell to sub-zero prices for a small number of trades in the front month. That was made possible by the lack of desire for end-users to take delivery of crude oil. A year later, we are seeing a similar disdain for producers to lock into agreements to make delivery (not take delivery) of corn. In short, it is the opposite scenario. The crude oil fiasco was made possible by the sudden decline in demand for oil during the global lockdown. In corn, demand is robust, but the issue is on the supply side of the equation. Farmers in the U.S. are reluctant to lock into agreements with grain operators because of concern their yield won't be as plentiful as it should be based on the number of acres planted. Simply, farmers aren't sure what they put into the ground will come out as a viable and deliverable product due to weather concerns. If dryness continues, this year's crop could be vastly disappointing. Soybean Futures Like corn, soybean rallies tend to be temporary...or transitory as the Fed might say. The price of soybeans has doubled in the last year but has yet to reach all-time-high status. Nevertheless, while we have seen spikes to higher price levels, we have yet to see soybeans hold comfortably above $15.00 per bushel for long. While $18.00 soybeans is a real possibility, $10.00 is a high probability. Source: QST Lumber Futures Lumber futures are the perfect example of a market that most retail traders should stay away from. The trading volume is dreadful, leaving wide spreads between the bid and ask prices, plenty of price slippage, and risk of unruly squeezes. To put things into perspective, the most active expiration (July) traded a mere 454 contracts Wednesday with an open interest of just 1581. As you can imagine, a small market with few participants is ripe for tulip-type rallies. Lumber futures have always been illiquid, which is a tell-tale sign that end-users (homebuilders) and producers (sawmills) are probably not hedging their price risk properly. As a result, the impact of COVID on the economy has been exaggerated in the price of lumber. Lumber bottomed in early April 2020 near $250 per board foot and has recently blown past $1,550! This is clearly a monstrous price move in a commodity that plays an integral part in the economic expansion (homebuilding). However, it is also unfair to use lumber as some sort of a bellwether of inflation when the price spike can likely be attributed to the perfect combination of illiquidity, questionable hedging habits by cash market participants, and unprecedented swings in demand at the hands of a rare global pandemic. Source: QST Conclusion Parabolic market rallies often come with the this time is different mantra. Sometimes that turns out to be the case, but most of the time the hype wears off, reality sets in, and prices collapse. In the case of commodities, particularly agricultural commodities, the best cure for high prices is high prices. Producers and farmers take note of the attractive commodity pricing and increase their production accordingly. Money talks.

A Bushel of Reality for the 'Commodity Supercycle'

The diamond hands that worked for some in GameStop stock and cryptocurrencies likely won't work in corn and soybeans.

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