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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Grains up on short covering; softs supported by tight supply
Ole Hansen
Head of Commodity Strategy
Summary: The grains sector trades higher for a sixth day as the beaten-down sector tries to recover from a four-year low reached earlier this month. While the trigger has been some emerging supply concerns in South America and the Black Sea region, the driver has been short covering from speculators who recently held the biggest net short positions across all the major grain and soy contracts since 2019. Also a look at the softs sector which during the past year has outperformed the grains sector by more than 40%, most recently driven by fresh peaks in cocoa and Robusta coffee.
The grains sector trades higher for a sixth day as the beaten-down sector tries to recover from a four-year low reached earlier this month. The trigger behind the latest attempt to bounce has been driven by continued turmoil in the key Red Sea trade route, tensions between Moscow and Kyiv adding to concerns about wheat supplies, and not least weather worries in South America.
These developments have forced the hand of hedge funds and other large speculators, who have been net sellers since November of the six major grain and soy futures traded in Chicago. In the week to January, the weekly Commitment of Traders report showed an increase in the net short to 496,000 contracts, the second biggest bet on lower prices on record, and only exceeded by a 707,000-contract short in May 2019. A short position which back then led to a four-week 20% bounce in the Bloomberg Grains index.
Large money managers such as hedge funds and CTA’s have, since early December when the Red Sea crisis started, increasingly been diverging their crude oil exposure away from WTI towards Brent. According to weekly Commitment of Traders reports provided by the major futures exchanges in the US and Europe, the combined net long in WTI and Brent slumped to a 12-year low in early December at 171k contracts or 171 million barrels, with the split between Brent and WTI being 57% and 43%.
However, the combination of the Red Sea crisis disrupting normal supply routes and rising US production have since then triggered a major divergence between the two. While the general rally in crude oil from the early December lows has seen the total net long jump by 85% to 317k contracts, the split between Brent and WTI has decisively moved in favor of Brent with 72% of the total net long being Brent. Investors appear to have concluded production growth will continue to pressure prices in the United States while the Middle East conflict will provide some support for prices in Europe and Asia.
If we widen the agriculture focus to include the soft commodities such as cocoa, coffee and sugar we find that the sharp divergence in performance seen last year has continued into 2024. Last year cocoa and coffee were two of the best performing commodities while wheat and corn were found near the bottom. The result being a YoY return for the Bloomberg Softs index around 21% while the Grains index has lost around the same percentage.
Tight supply risks boost soft commodities
With the current focus on an economic downturn potentially hurting demand for growth-dependent commodities, we have recently been reminded that prices are not only dictated by demand but also the availability of supply. The Bloomberg Softs subindex reached a fresh nine-year high this past week, supported by adverse weather impacts on production, especially across the Southern Hemisphere where the impact of a returning El Niño is being felt, in the process driving down available stocks. The rally has been led by cocoa which has soared the most in six years to reach a fresh 46-year high, as resilient demand put pressure on tight supply due to declining production in West Africa, especially top grower Ivory Coast which has seen deliveries of cocoa to ports being down around 37% compared with this time last year.
The coffee market has also been on fire recently, not least driven by Robusta coffee, which has reached a fresh record high as farmers in top producer Vietnam hold back on sales in anticipation of even higher prices. A move that has only been made possible by near record low stockpiles in exchange monitored warehouses. In addition, the Brazilian production of Arabica coffee has also disappointed, and with exchange monitored stocks at a 1999 low, a current lack of containers in Brazil leading to port congestions, as well as the Red Sea disruptions have all supported prices recently.
Some of the above-mentioned bullish drivers may eventually solve themselves, thereby lifting supply, and while it may drive a long overdue correction, the underlying support from weather related tightness is unlikely to go away until the impact of El Niño starts to ease.
Commodity articles:
23 Jan 2024: Silver and copper in focus after recent declines
19 Jan 2024: Commodity weekly: Middle East, US rates, Bitcoin ETFs & Freight rates
17 Jan 2024: Natural gas focus switch from cold to milder weather ahead
16 Jan 2024: Data dependent precious metals continue their bumpy ride
12 Jan 2024: Commodity Weekly: Geopolitical risks lift crude and gold prices
9 Jan 2024: Q1 Outlook – Year of the metals
5 Jan 2024: Commodity weekly: Bumpy start to 2024
4 Jan 2024: What to watch in crude oil as 2024 gets underway
4 Jan 2024: Podcast: Crude oil and gold in focus as a new year begins
21 Dec 2023: Weather, rates and unrest paint muddy picture for commodities in 2023
19 Dec 2023: Crude and gas pop on Red Sea Disruption Risks
14 Dec 2023: Fed's dovish tilt adds fresh fuel to precious metals
13 Dec 2023: Video - Why gold may enjoy a Santa rally for the 7th year in a row
12 Dec 2023: Video - Investing in Uranium
1 Dec 2023: Commodity weekly: Tight supply risks boost copper; OPEC+ struggles to control crude
30 Nov 2023: Precious metals take top spot for a second month
23 Nov 2023: A nervous crude oil market awaits OPEC's next move
23 Nov 2023: Podcast: Will Santa deliver another golden gift
22 Nov 2023: Will gold and silver see another Santa rally?
17 Nov 2023: Commodity weekly: Crude overshoots; silver the comeback kid
16 Nov 2023: Podcast: Silver comeback, watch OPEC as crude oil slides lower
16 Nov 2023: Crude oil weakness adds focus to upcoming OPEC meeting
15 Nov 2023: Soft CPI lifts gold and beaten down silver and platinum
12 Nov 2023: Copper supported by green transformation demand and peak rate speculation
10 Nov 2023: Commodity weekly: Crude oil risks overshooting the downside
Previous "Commitment of Traders" articles
22 Jan 2024: COT: Commodities short-selling on the rise amid China woes and Fed caution
15 Jan 2024: COT: Grains sector slump continues; Mideast risks lift crude demand
8 Jan 2024: COT: Weakest commodities conviction since 2015
18 Dec 2023:COT: Crude long hits 12-year low ahead of FOMC bounce
11 Dec 2023: COT: An under owned commodity sector raising risk of an upside surprise in 2024
4 Dec 2023: COT: Speculators add further fuel to gold rally
20 Nov 2023: COT: Crude selling slows, grains in demand
14 Nov 2023: COT: Crude long slumps; agriculture sector in demand
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