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29 March 2024

Investor money is flowing back into commodities

The El Nino weather pattern could effect wheat output in several countries. (SUPPLIED)

Published
By Shashank Shekhar

The global economic crisis has unfolded with two lessons. One, real estate prices will not perennially rise. And two, commodities – agriculture included – are not a "dirty class" fit to be touched only by lesser mortals.

Two reports released simultaneously point out that the commodities markets have consolidated and are recovering across segments from crude to metals to agriculture. The Merrill Lynch and Standard Chartered reports come close on the heels of a survey carried out by the financial consultant Watson Wyatt which said the percentage of investments of pension funds into commodities classes remain at a measly low of 0.4 per cent of the entire portfolio.

The global consultant, however, said indirect investments are much higher and even this ratio is expected to increase after the crisis.

Francisco Blanch, Head of Commodities Research at Merrill Lynch, wrote in his recent report that though the markets have remained flat in June, there was evidence that the sector was attracting renewed investment.

"Following substantial withdrawals in the second half of 2008, investor money is starting to flow back into commodity indices on the back of rising prices and an incipient recovery in risk appetite. Our estimates put the total amount of money currently invested in commodity indices at about $125 billion (Dh459bn), up from a trough of $80bn in February."

What has particularly made investments into commodities a better prospect is the launch of several new exchange-traded funds that make lief easier for those wanting to get an exposure to commodities.

"We argued in a recent publication that more speculation would benefit commodity markets by reducing inefficiencies found in commodity options and timespread prices. We also found statistical evidence that passive investor inflows into commodity markets tend to follow prices rather than the other way around. This evidence is consistent with investor inflows into the commodity markets observed in recent months. With commodity prices bottoming out early in the year and steadily creeping higher, investors are starting to dip their toes again into the market," said Blanch.

Analysts at Standard Chartered, who conducted a study of prices of base and precious metals besides crude and agricultural products, said commodity prices, although they have declined, now are expected to show an upswing. "Commodity markets have moved into a consolidative phase as the markets await evidence of the anticipated bottoming of global growth expectations. Demand remains weak across most sectors and there is still considerable uncertainty surrounding the sustainability of the strength of China's commodity imports. The Dow Jones UBS commodity index fell 1.7 per cent on the month, but is still up 7.7 per cent year to date. We maintain our view that demand will begin to strengthen in Q4 and into 2010 as emerging market growth picks up. The US dollar weakness will also be key to driving prices higher," a three-member team of commodity analysts led by Helen Henton, the head of commodities research at Standard Chartered Bank, wrote in the new study.

"We are relatively more bullish on energy as the supply situation is tighter – we expect the capacity overhang to weigh on the base metals complex and steel prices. While agricultural prices have tumbled this month as the market shed its near-term weather premium, we continue to believe that weather-related risks have not been fully factored in for next season," she added.

Both Merrill Lynch and Standard Chartered cited several commodities indices from Dow Jones–AIG to the S&P Goldman Sachs to make the point that the markets have bottomed out.

Perhaps it is this upswing, which comes prior to similar reflections in other aspects of the economy that analysts at Watson Wyatt conclude that more pension funds will invest into commodities.

Pension funds are likely to have a 5-10 per cent allocation to commodities, David Hoile, Head of Asset Research at Watson Wyatt, said. Of the $872bn held in alternative assets on behalf of pension funds by the 100 largest managers, a meagre 0.4 per cent currently resides in commodities, he said, adding that indirect investments could be much higher.

Agriculture

Since precious metals, crude and base metal performances have seen a lot of discussion in the media it will be interesting to discuss the performance of agricultural products that have so far remained elusive from media focus. Acreage report pulls market lower but weather concerns should provide support long -term agricultural commodity markets, led by grains, Standard Chartered said.

"Grain prices have been trending down, as the market sheds its weather premium, given favourable growing conditions in the US wheat and corn belts. The grains market was also dampened by a US congressional report recommending tighter restrictions on commodity index traders and excessive speculation," Abah Ofon, the 'Softs' analyst at Standard Chartered, said.

Ofon said although the bumper harvests being reported from different parts of the world may reduce the supply demand gap, it will adversely affect the prices.

"The market was heavily wrong footed by the US Department of Agriculture's acreage report at the end of June. This showed that, despite a wet spring, farmers planted 87 million acres of corn this year in the US, the most since 1946 and well above trade expectations for 83.986 million acres. Rice prices have also capitulated as supplies swamp the market. In fact, Vietnam reported a 56.2 per cent hike in H1 exports due to a bumper harvest."

The star performers in the agriculture sector have been sugar and soybeans.

In fact soyabeans price rallied up recently on reports that China was stocking it. "We have been bullish on both commodities for most of the year on supportive fundamentals. Yet we felt that on balance there was more bearish news on the horizon – given better crop prospects – and we had been reluctant to call prices higher. Nevertheless, recent developments in the market, including continued purchases of soybeans by Chinese processors and dimmer prospects for Indian sugarcane output, are changing the dynamics for these two crops to more bullish. This month, therefore, we are revising our near-month forecasts higher for sugar and soybeans but we hold to the view that prices will correct to the downside as the global soybean and sugar balance eases," Ofon said.

A number of unknowns, including the weather, are creating greater volatility in prices, making the market harder to call, Ofon wrote, adding that the El Nino weather pattern could effect wheat's output in countries as distantly located as Australia, Argentina and India.

This month the Australian Bureau of Meteorology noted that an El Nino weather pattern that could bring drought conditions to Australia's farmlands this year could be officially declared within weeks. This could have a material impact on Australian wheat output and exports, which have been adversely affected by drought conditions over recent years.

"Argentina could also exit the wheat export market next season due to a historic drop in wheat plantings. Australia and Argentina are traditionally the top five wheat exporters. The resulting below-normal rainfall in Southeast Asia, coupled with weaker monsoon rains in India – as a consequence of El Nino – could also dampen edible oil output in that region. We believe these weather concerns to be significant but we see little evidence of a weather premium being priced into commodity prices at the moment. This leads us to conclude that risks to agricultural commodity prices remain to the upside," Ofon said, adding the adverse weather would impact the prices.



Long-term outlook


Cocoa

Standard Chartered took a bearish view of cocoa. "We maintain our bearish stance on cocoa in the short term, due to a drop in grindings in Europe and North America. The ICCO projects a drop in grindings of about 6.5 per cent to 3.515mt, on the back of surplus global inventories. Nevertheless, we believe the market should improve in Q3 due to firmer seasonal demand," it said.


Coffee

Increase in global supply is capping prices for now, Abah Ofon, the 'Softs' analyst at Standard Chartered, said. "Supply prospects over the short to medium term look likely to be given a boost after farmer incomes in Brazil – the world's largest coffee producer and exporter – have been boosted by a BRL1 billion (Dh1.88bn) subsidy, largely intended to help with the harvesting of the new crop. Angola, meanwhile, is looking to revamp its coffee sector, which was devastated by a long-running civil war. Angola expects to produce 12,000t of coffee this year, up from 5,000t last year, and is investing $150 million (Dh550m) in the sector. Elsewhere, Vietnam's coffee exports in June fell 11.5 per cent to 1.42 million bags."


Sugar

Market opinion remains divided as to how much sugar India will have to import this marketing year, but consensus seems to be that it will be closer to 3mt of sugar, which is seen as bullish, Ofon said. "The primary drivers of prices in recent days have been speculative interest and energy prices. We, on the other hand, are bearish about sugar at current levels, although we believe speculative interest could still drive prices higher near term."


Cotton

"Despite the pullback, cotton prices may trend higher over the next 12 months, based on increased mill use. The length of any potential rally will likely be capped by large stock holdings by the governments of the three largest consumers – China, India, and Pakistan," Ofon said.


Wheat

Ofon believes risks are to the upside as weather concerns will dominate. "Bad weather will potentially slash output in the southern hemisphere," she wrote.


Corn

Consultants ARC report that based on rainfall and temperature data to date, corn yield reductions of 15-20 per cent are likely. If the weather stays hot and dry for another two to three weeks, losses could approach 30-45 per cent. "We retain our stance that corn prices will rise, and we base this on the view that there is currently very little weather premium factored into prices," Ofon said.


Rice

Ofon sees a little upside for rice prices in the very short term, on the back of bumper harvests in South East Asia, including Thailand and Vietnam. "However, we expect a moderate pick-up in prices in the fourth quarter due to firmer wheat and corn prices and a moderate increase in demand from large importers such as the Philippines."

Soybeans

Soybeans have been one of the most discussed commodities this year as the Chinese stockpiled it earlier this year just as they did with crude, copper and steel.

Return of Chinese demand will be bullish for soybeans, Ofon said. "Reports from ARC indicate that China is likely to keep the seven mt of reserve stocks built in the first half of the year until the first half of August, rather than sell it into the domestic market, as concerns about the weather entrench the need to maintain strategic stocks. Moreover, better soybean margins are improving the attractiveness of soybeans for crushers, particularly from China, and pushing processors to process soybeans and keep the meal market supplied."

 

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