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Commodity Report: Are Higher Prices Here To Stay?

AMEX:DBA   Invesco DB Agriculture Fund


1. Commodity Currencies

Australia, Canada, and New Zealand all have commodities that fluctuate with respect to commodity prices. As demand for these countries' export has risen and commodities have increased in value, these three currencies have appreciated. As the dollar depreciates, commodities become cheaper.

A. Aussie Dollar

Australia is a major supplier of copper , iron, and aluminum. As manufacturing picked up during the reopening, demand increased. Minerals and fuels make up close to 50% of Australia’s total exports.

B. Canada Dollar

Canada is a top 5 exporter of Oil . The price of Oil and the CAD will move together in the medium-long term. Canada is rich in Lumber, Gold Mines, Iron Ore, Copper Ore, Aluminum, Coal, Lumber, and Nat Gas.

C. Kiwi Dollar

New Zealand's economy is heavily dependent on Agricultural products used for food around the world. Dairy, Beef, and various fruits are supplied to the world from New Zealand.

D. US Dollar

Cash is King. Notice how commodities move with AUD, CAD and NZD compared to USD.

2. Agriculture and Food

DBA (Pictured in Featured Chart)
- Food is the most important commodity in the world because it is needed for survival. If a breakout occurs from the ten-year channel consumers will see higher food prices. DBA holds exposure to Soybean , Corn , Sugar , Coffee , Hog, Cattle. Unlike other markets, food does not see a decrease in demand when prices increase. DBA has increased due to Covid, Supply Chain issues, below-average crop yield, and an increase in inflation . When food gets too expensive be on the lookout for social upheaval, riots, and unhappy citizens . In poorer countries, more of a household's income goes to food. When looking at commodities , we need to focus on the relationship between demand and supply. If general demand for goods continues with strength there may be an investment opportunity here. Increased supply along with any negative effects to supply will cause an even bigger price increase.

A. Chinese Yuan

As you may have seen in the news, China is incredibly susceptible to these increases in food prices because they import a lot of it. On the other hand, the US is the biggest exporter of food. The Chinese Yuan exchange rate with the US dollar moves with US inflation and global agricultural prices. The Yuan will rise with respect to the US dollar . With the dollar depreciating, the US balance of trade ( export-imports) will increase improving the competitiveness of domestic goods in foreign markets.

B. Soybean

Soybeans demand has increased as it is being used in biofuel production, animal feed and food products outpaced production growth, resulting in a significant hike in soya prices. China has been a big bidder of soybean and has taken the brunt of the higher prices. US and Brazil have started to up their production to cope. Soybean is used a lot as a feeder for livestock.

C. Corn

Brazil has been ravaged by drought making its crop yield fall below expected production. With ethanol production coming back to normal, it has affected the allocation for food.

"For corn , the USDA pegged the U.S. old-crop ending stocks at 1.10 billion bushels vs. the trade estimate of 1.20 billion bushels and the USDA’s May estimate of 1.25 billion.
For soybeans , the U.S. ending stocks were 135.0 million bushels vs. the May estimate of 120 million bushels. The trade expected the USDA to print 122 million bushels today.
In its report, the USDA pegged the U.S. wheat ending stocks at 852 million bushels vs. the trade’s expectation of 869 million and the USDA’s previous estimate of 872 million."
- Agriculture.com

All in all, it seems like the market for Corn , Soybean , and Wheat is in the process of reverting back to the mean if, heavy droughts do not persist. The US will continue to see a high demand for these crop exports.

D. Live Stock: Cattle and Hog

The Cattle market IMO is the most manipulated market. The Big 4 distributors Cargill, JBS, Tyson, and National Beef control 80% of the cattle market. Feed Cattle is cattle that need to be sent to a feedlot to fatten up and get ready for butcher. The price ranchers receive for their cattle has only increased by 5% while, the wholesale price the big 4 packagers receive has increased 50%. This is good news for the Big 4 corporations but negatively affects the ranchers and consumers. Packers have artificially been affecting the price of cattle to benefit them by coordinating bids and creating artificial cattle surpluses to push down prices. Hog Prices have been affected by increased feed prices, supply chain issues, and the swine flu.


3. Energy
Energy trades have outperformed FANG stocks, SPY , IWM , and Tech stocks by over 40%. Individual stocks have experienced higher returns. Most Energy names are approaching overhead resistance however, it looks like they are starting a rally rather than ending. As the world reopens, the basket of energy trades will benefit.

A. Crude and WTI
As the economy reopens, people are starting to utilize cars and planes for travel and work. The demand for gasoline will increase. Looking at Oil prices from the last 15 or so years, we see the oil still has room to upside. Do you believe that we are in the early stages of demand recovery? Global oil demand has already increased by a million and a half per day; by the end of summer can we see 99 million barrels? Oil bulls would like to see us drawing from inventories.

B. Natural Gas
Natural Gas has been in a decade-long bear run. With a very hot summer expected, there will be a lot of people pumping their ACs . Industrial demand is expected to remain strong and as Liquified Natural Gas returns to pre-pandemic levels. There is a possibility this can run higher. However, like other agriculture and energy products, it can make for a choppy trade. As oil production increases, associated natural gas which is a by-product of oil will increase the natural gas supply. Many producers are saying that even if there is a big increase in the price of natural gas , they will not increase their production.

C. Uranium
Uranium is looking to explode out of the base it has formed. The uranium spot price is hovering around $32 well below $60 which is needed to incentivize miners to find new suppliers. Uranium is one of the most undervalued commodities IMO. Biden's clean energy initiatives will call upon Uranium. He is pouring money (~1.8 billion) into Nuclear power research

D. Coal
Coal continues to head higher based on higher demand.

E. Clean Energy ETF
Clean Energy looking for a place to bounce from.

F. Small Cap Energy
Small-Cap Energy IMO has the best potential for upward mobility in the commodity sector. Energy has not taken off like other commodities and with more energy products being used with reopening and travel along with higher prices; we can see these smaller names blast off.

I would not be a buyer of Oil but a buyer of Oil producing companies. They have the most to gain from higher oil prices. The same goes for other types of energy. For example, my biggest winners have been OIH , TELL, and CCJ .
ex. GUSH, GTE, CDEV , CPG , REI

G. Oil and Gas Exploration
Energy prices are soaring, Ethanol, Natural Gas , and OIl have benefitted from inflation and increased demand. XOP has a very diverse portfolio and is undervalued relative to the price of Oil . The last time oil was in the $70s, XOP traded around 130-160. Look at the price now. Looks bullish with the bottom in place

4. Metals
Many Mining and processing companies suffered large losses from bad demand during covid and now they are with a limited amount of capital to scale back up. This ETF will go down once there is sufficient supply to handle the current level of demand. Raw materials are the input used in the industrial and manufacturing sectors.

When XME outperforms markets the economy grows. When XME underperforms, the economy slows. The business cycle peaks with rising interest rates, energy prices, and when inflation reduces consumers’ purchasing power due to higher input prices. This results in less demand, slowing economic growth. Businesses will be forced to cut production to reduce inventories. Decreasing the purchase of raw materials, slashing the labor force. Less borrowing occurs due to interest rates. The result is lower commodity prices, lower wages, and lower interest rates. The result is steadily declining inflation . During such times sectors such as staples, healthcare, utilities, and bonds outperform the markets. Pretty much the sectors whose demand stays constant. Cyclicals, industrial, metals and mining, and financials underperform the markets.

A. Silver
Silver looks pretty neutral right now. It has been trading rangebound since August. Silver in the long term moves with Gold .

B.Gold - Cost of Carry

Gold is a hedge against real interest rates. If rates go down, expect Gold to go up. If rates go up, expect Gold to go down. 50% of Gold is used in Jewelry, 37% in Electronics, and 13% are used in Coins/Misc. If you ask a Jewelry store when business is best they will say when Gold prices are low. Gold prices are Low when the economy is booming and people got money to spend. (Rates are low) Also, when people got money to spend they buy more electronics. When there is uncertainty in the market Gold booms. It is best to hold Gold when there is "blood on the streets" - Rothschild.

C. China Iron Ore and US Steel

FEF1!- Ran up a lot. High Iron Ore prices do not attract as many buyers. This chart tracks the price of China's Iron Ore import from the port in Tianjin. (62 percent grade Spot Cost and Freight)

Iron Ore is used to creating Steel. Iron Ore and other compounds are placed in a furnace and blasted with heat. China is by far the biggest importer of Iron Ore then their factories are used to transform it into steel. back in the early 70s, Mao Zedong looked to transform China from an agricultural-based economy to an industrial nation. Steel is needed for buildings, factories railways, bridges, roads , and dams. So, they looked to Australia for Iron Ore. Initially, Australia's iron ore mining was meant to supply the Japanese Steel factories. China took advantage of this and their GDP accelerated in the following. However, this has left China heavily reliant on Australia and Brazil the two biggest exporters. A trend in China has been to reduce its exposure to higher commodity prices. This can be seen best with Soybean and Iron Ore. China has banned the export of steel in an effort to reduce prices and stir a trade war with Australia. China's steel production is at an all-time high. Steel demand is seasonal , highest in the early summer months due to peak construction. With supply coming back in Australia and pandemic stimulus slows, Iron Ore should come down in price.

X - US Steel

The so-called "booming" US economy has led to higher Steel prices and a surge in demand. Steel prices will continue to be high if there is a below-average supply and if China's export ban increases global steel prices. There is still a lot to be determined. Again we need to look at supply and demand .

D. Copper

Copper just like steel has benefited from the relation trade but is now seeing weakness due to China not accepting these higher prices. China decided to release its reserve and introduce higher levels of supply to the market. Copper prices reached all-time highs on the back of higher manufacturing and industrial output. If you are bullish on FCX and copper prices you would believe that China would be unsuccessful in holding Copper prices down. The top chart shows the relationship between Copper / Gold . The ratio can be simplified to Risk On vs Risk-Off; the physical economy vs financials. Copper is heavily dependent in the cyclical sectors (industrial and manufacturing) leading to economic growth is a leading indicator for US treasury bonds. Copper is mainly used in electronics. The latest news is that there is an excess demand for Copper leading to a shortage.

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Chile's currency appreciates along with its biggest export Copper . Looking at USD CLP will help us decide the direction Copper goes and in turn if the economy continues to grow.

E. Platinum and Palladium

Platinum and Palladium have historically been used in automobiles for catalytic converters. However, Palladium has replaced Platinum in recent years due to it being a cheaper alternate. As automobile manufacturing picks up, Palladium has been in such hot demand that companies are looking to go back to using Platinum. Palladium and Platinum are both hard to mine so, the price appreciated with the increased demand and dwindling supply.

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Platinum/ Gold and Copper / Gold tell the same story. They are both leading indicators for the US10Y . We see their price action have all been very similar. US10Y could be heading lower?!

F. Aluminum

5. Lumber, Housing Index, Mortgage Backed Securities

A. Lumber

Lumber is one of my favorite commodities because it tells you so much about the economy. It tells a story about Agriculture, Industry, Manufacturing, Production, and Transport. Lumber cannot be transported by USPS or a regular delivery man. Lumber relies on large-scale transportation to get to its destination. As you may have heard Lumber has been at incredibly high levels. However, now we are seeing Lumber give off some of its gains. The demand for Lumber is dropping. How low will Lumber prices fall? With such high Lumber prices, consumers no longer wanted to purchase at such high prices and held off their use for Lumber. XHB , The homebuilder ETF has also slowed down. Homebuilding has been hurting because of the higher lumber prices leading to more expensive houses and fewer houses being built.

aa.

Markets usually follow this ratio. Lumber is sensitive to housing and domestic economic growth. Housing is usually the bulk of an American's capital expenditure because, buying a house is inherently risky due, to the leverage component. Most Americans are in the housing market, not the stock market. Housing has always been the best leading indicator. Gold on the other hand is ubiquitously popular in periods of high volatility and defensive play. This ratio tells you when to ‘apply more gas’ or ‘take your foot off the pedal’.

Whenever, this ratio has been bullish , Lumber > Gold . I have allocated a larger percentage of my portfolio into small caps. Hiding out in small caps when you see a sustained uptrend in Lumber/ Gold is a simple trading strategy. Higher Lumber prices signal consumer wealth which goes hand in hand with small caps which are sensitive to the domestic economy and the spending habits of consumers. Even as rates have risen, Lumber has not faltered. Mortgage rates have a huge effect on housing prices. As rates rise, loans get more expensive and less money can be offered for houses. Americans are known to make speculative plays with their houses. Refinancing, floating-rate mortgages, and home equity loans are ubiquitous leading to a very fragile market. Americans view their house as a piggy bank. This works until housing prices fall.

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Holds companies that deal with building and prefabrication of residential homes, mortgage insurers, and suppliers of building materials

B. Mortgage Backed Security ETF

Will Americans be able to pay their mortgage? Let's not forget that the FED is buying MBS and Treasurys every month. This ensures that mortgage rates stay low.

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As we go into the two-day FOMC meeting, one may wonder if the Fed will be forced to tighten economic conditions. Chances are the Fed writes off the inflation experienced by markets as transitory. With the Fed looking for full employment they may seem to not mind seeing the economy run hot. There is no reason for the Fed to make a move now. However, with the economy heating up this summer it will be important to watch commodity prices for any future moves the fed may make. There are many inflationary pressures and the ten-year yield looks to reach 2%. The stimulus for businesses and people, foreclosure moratoriums, overall debt build-up (credit cards, auto loans, student loans, margin loans), large amounts of QE , and rent moratoriums have caused an unstable market. With inflation creeping up the Fed will eventually have to cut back on QE and raise the Fed Funds rate as history has denoted. With many commodities on the verge of breaking out, we can see a blow-off top through the summer followed by a credit bust similar to 2008. A seemingly inflationary environment can be put on its head and lead to deflation with 50-70% drawdowns in many overvalued stocks. Will Cash reign as King again? What you will see in common with the charts below are that most of these commodities formed a bullish head and shoulder pattern from the fall of 2019 and are now approaching levels of resistance such as agriculture and energy whereas, commodities like Lumber and Copper have moved parabolically. In 2008, you will notice a lot of these commodities were at very high prices; there must be a chance we see these levels with the amount of debt floating around. Rising commodity prices lead to winners and losers. Those selling the commodities benefit in the short run and buyers are forced to take on the higher prices.
Be Greedy when those are Fearful and Fearful when they are Greedy. People are super fearful of Inflation , should you get greedy on the contrarian view? I know this article sends a lot of mixed signals but, I do not predict the future nor can I teach you how to invest. I am trying to shed light on what you should be looking at to make your investment decisions.
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