The biggest central banks in the world are competing for being the best in destroying their respective currencies by printing. The process spans from Japan to Europe but in the US there is no official QE. Many observers talk about a very high possibility of returning to the printing press and this makes investors attracted to tangible assets. It is a very good option considering how low the price of most metals is today. Today we are at the level of 2009 bottom.
More people are interested in agricultural commodities today due to the phenomenon of El Nino/La Nina. The change of sea currents happens once per several years and causes severe weather conditions. Keeping a cool head about the catastrophic forecasts of El Nino this year, we have to acknowledge (based on previous years) the fact that commodity prices climb during this event. Last time it happened in 2011.
The price and its past
A major index showing how agricultural commodities are performing – GKX – takes into consideration different kinds of food products and grains. A chart below shows you history of this index from 1997 to 2016:
Above you can see two speculative bubbles in the agricultural market. First one, in 2008, pushed the price up to 500 points after which the GKX was trading at half of that price. Another rally, in 2011, was due to El Nino and then the level of 550 was broken. Since then we experienced nearly 50% drop and we are close to the bottom from the beginning of this year.
There are arguments to suggest that the level of 150 points (bottom of 1999 and 2002) is what we are heading for. Another factor to include in our evaluation is the depreciation of a currency. The rate of dollar inflation is higher than official data which confirms that main agricultural commodity index has bigger potential to gain than it has to lose.
When you analyse commodities, pay attention to ETNs investing in futures. One of them is RJA (Jim Rogers’ ETN) based on a wider array of commodities than the GKX. This is how it looked during last decade:
If both charts show agricultural indices then why we see differences? As I mentioned before, Rogers is using a wider spectrum of commodities but their share better mirrors global supply. You still can see common trend – the plunge after 2011 and rally in the beginning of 2016. I want to highlight recent correction which made today’s levels look very attractive.
Technicalities of agricultural commodities
Investing in commodities is much less popular than buying equities or bonds. This is why it pays to know some characteristics of this market. Firstly, prices of indices correlated with agricultural commodities are very dependent on investors’ mood. It looks like a self-perpetuating cycle where the relation between supply and demand has no significant meaning. The perfect examples are events of 2008 and 2011. In the former, the weakened dollar played the main role. Historically speaking, the weaker USD is the better commodities are doing and vice-versa. When the dollar was losing during 2007-2008, investors expected higher commodity prices. This generated a speculative bubble which ended at the bottom of 2009. Anno Domini 2011, similarly to today, was the year of El Nino. The expectations of higher prices spread among investors and the market experienced the last boom in commodity markets.
A big share of equity investors knows from experience that a bull market is spread across time, unlike a slump. The mass panics making assets lose value in a very short time. When it comes to agricultural commodities it is different. When prices are going up in the back of the investor’s head a thought emerges: “I have to buy now because it may be too late very soon”. This makes rallies very strong, an example of doubling the price of coffee in just 4-5 weeks is one of many. When deciding to invest it is worth remembering this.
Comparison of commodity prices
I wanted to show you where agricultural commodities are today compared to previous years. I created my own index of seven commodities (from the top of the global supply list). Data compares the peak of 2008 bubble, bottom of 2009 and price today. Comparing prices from different periods is necessary for the situation where GKX, ETN RJA are distorted by a small margin due to contango. Comparison only based on the respective commodity price can lead to errors especially in the longer period of time.
My index is based on several commodities: Corn (22% weight), wheat (22%), cotton (18%), soy grains (14%), coffee (9%) and sugar (6%). On the left, you can observe how prices changed each year. On the right side, you see their index-weighted price.
Above, the green field shows the index level of 2008 – peaking price. In the red, you can see prices from 2009 (57% drop from the maximum). Today, at 345 pts, commodities are closer to the 2009 bottom than to 2008 peak.
Our evaluation should also pay attention to inflation recorded between 2009 and 2016. According to shadowstats.com (calculating the rate of inflation with the ‘80s formula), cumulated (since 2009) increase in prices was equal to 89%. A similar rate of inflation gives us the Chapwood Index - a basket of 500 mostly bought products in various regions of the US. Factoring inflation into our analysis it seems that prices of commodities are very close to or even lower than their levels in 2009.
In case prices of commodities will climb as expected, investment in RJA is going to be very profitable. If this scenario materialises, I would also expect AUD and NZD (two currencies with the strongest correlation to commodities) to appreciate.
I invested in Jim Rogers RJA (37 most important agricultural commodities) in the beginning of 2016 and now I wait patiently for the price to go up.
More expensive agricultural commodities have also other consequences. Higher prices mean a catastrophe for poor countries. Wherever households spend 50-60% of their budget on food, hike in prices is one of the worst things that can happen. History shows that poorer countries can see riots and violent protests.
Independent Trader Team