Agricultural produce exchange-traded commodities (ETCs) have posted impressive returns in recent weeks as growing demand and supply shortages created a perfect storm for backwardation.
The WisdomTree Corn ETC (CORN), WisdomTree Soybean Oil ETC (SOYO), WisdomTree Wheat ETC (WEAT), WisdomTree Sugar ETC (SUGA), WisdomTree Agriculture ETC (AIGA), along with currency hedged versions, were among the best performing strategies across all ETPs in April returning between 13.4% and 22.2%.
In a similar situation to other commodities such as industrial metals, agricultural goods have found themselves in a sweet spot for backwardation, with economic recoveries prompting demand growth, while supply remains hampered by factors such as weather.
While pundits expect La Nina events to reduce corn output by 8% in coming months, demand for coffee has spiked as lockdown restrictions ease and the Bloomberg Grains Total Return index has doubled to hit a six-year high since last August.
Ole Hansen, head of commodity strategy at Saxo Bank, said: “The agriculture sector, led by grains have witnessed a perfect storm of price supportive developments during the past six months.
“Driven by the combination of record Chinese demand for corn and soybeans at a time of supply tightness driven by a month-long period of drought in Brazil.”
Another input supporting the prices of softs and grains has been the return of trading activity from hedge funds with the number of futures positions taken out at their highest level since 2012.
These developments, along with investors jumping on the returns bandwagon, have seen the speculative demand for key commodities such as corn, soybeans and sugar reach record levels.
Hansen said spot market tightness and increased demand have driven grains back into strong backwardation for the first time in five years and this works to the benefit of those in passive long positions via ETFs.
The question on many onlookers’ minds now is how long the current surge can last, given that the spread of COVID-19 cases has proven temperamental and factors such as weather are entirely out of participants’ control.
Hansen continued: “Any change in the technical and/or fundamental outlook could trigger long liquidation and with that a reduction in the current backwardation.”
With large price spikes already seen – and with agricultural commodities normally moving in short cycles – Hansen said the asset class is less useful than other commodities such as metals and energy in acting as a hedge against risks such as inflation.
However, he concluded that the coming months would be crucial to securing the longevity of the current price rally.
“While it can take up to five years for mining and oil companies to increase production in response to higher prices, farmers can make adjustments from one year to the next,” Hansen said. “In other words, weather permitting, the supply of agriculture products are likely to rise following a year with high prices.”
The demand side is already playing out by way of inputs into the economic recoveries occurring around the world. It is on the supply side that prices of agricultural goods will be made or broken, and that, unfortunately, is unpredictable and largely outside of anybody’s control.