Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Grain market pops on big Q3 stock drop
Ole Hansen
Head of Commodity Strategy
Summary: The grain sector finished September and the third quarter with a bang after all three major crops rallied strongly on Wednesday. Overall it was a strong quarter for agriculture commodities in general with gains seen across all three sub sectors of grains, softs and livestock. Signs are that the trend will continue thereby supporting Central Banks desire for higher inflation, unfortunately in this case, the worst kind of inflation
What is our trading focus?
CBOT Soybeans - SOYBEANSNOV20
CBOT Corn - CORNDEC20
CBOT Wheat - WHEATDEC20
AIGA:xlon - WisdomTree Agriculture ETC (UCITS eligible)
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The grain sector finished September and the third quarter with a bang after all three major crops rallying strongly on Wednesday. This after U.S. Department of Agriculture stockpiles data showed corn, soy and wheat inventories all trailing the average estimates from analysts. As a result the Bloomberg Grains index finished the quarter up 12.3% to record its best quarter in more than five years.
Overall it was a strong quarter for agriculture commodities in general with the sector finishing up close to 12% with gains seen across all three sub sectors of grains, softs and livestock. With the strong finish for the grains sector there are now expectations that a lower U.S. production, due to adverse weather in August, and increased worries about a La Nina event will continue to support the sector over the coming months.
Thereby providing support to Central Banks desire for higher inflation, in this case unfortunately, the worst kind of inflation as it hurt consumers, especially in emerging market economies, that can least afford it.
A potential break on the current rally could either be another leg higher in the dollar which reduces overseas demand for U.S. farm products and/or the risk that China may pause its buying in response to the recent rally in both corn and soybeans.
As mentioned the quarterly stock report blindsided the market in showing a bigger than expected decline in stocks for all three crops at the end of last quarter. Heavy buying of soy and corn by China, as it rebuilds its massive hog herd after the African Swine Fewer outbreak, was a major driver. Adding to this lower U.S. yield estimates and dry weather in parts of South America could mean that the sector after years of oversupply will begin to tighten.
Bulging stocks from a continued rise in production in recent years helped keep the forward curves in a state of contango where the spot futures contract traded lower than the next. It meant that passive long only investors were facing headwinds from negative roll yields.
The rally during the past quarter across the whole agriculture sector have flattened the forward curves and sharply reduced the mentioned headwind. The average one-year roll cost using Bloomberg Commodity subindexes of 11 major food commodities has returned to zero for the first time since 2014
While supply and demand differences will always be the ultimate determining driver for prices, the removal of the contango headwind may potentially now also attract increased investment demand. ETF’s that are designed to track the performance of a basket of agriculture commodity futures are showing signs of breaking the downtrends which for most was established close to ten years ago.
An example being the WisdomTree Agriculture ETC (Ticker: AIGA:xlon and UCITS eligible) which is designed to track the Bloomberg Agriculture Subindex Total Return Index of nine major agriculture commodities. As per the chart, the recent rally has triggered a breakout with the next area of interest being $4.1, the January high Latest Market Insights
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