A lot has been made recently of the return of investors to commodities. Hard assets were pummeled in 2013, but are back in vogue. The CRB index shot to 16-month highs, and the rally in soybeans was nothing less than meteoric. Gold and crude oil also found favor, confounding many experts who expected falling prices for both in 2014.
But there's a difference to investors' love affair with the futures market this time around, and it could have a major bearing on crop values for the rest of the year. The buying over the winter in agricultural commodities almost entirely came from big speculators. They indeed were bearish last year amid forecasts for big crops and bigger surpluses. But other so-called passive investors were largely missing in action this time around.
That's a marked difference from the last two influxes of fund money into the sector. In 2006-2008 and 2009-2010, these index funds steadily increased the number of ag contracts they held. This segment of the market includes institutional investors like pension funds, who believed portfolio theory that said commodities could diversify their holdings and lower risk. This was because commodities previously moved independently of other investments, like stocks and bonds. These investors allocated some of their holdings according to popular commodity indexes, taking only long positions, the same way they bought stocks and bonds.
The theory didn't work during the financial crisis, however. Stocks and commodities both collapsed as liquidity dried up from all markets, forcing the indexes sharply lower.
Once the money started flowing again, investors got right back into commodities in 2009-2010. In fact, ag commodities were even more popular than before the meltdown, and the number of contracts held by index traders reached an all-time high.
But since that peak, index funds steadily cut back on their holdings. This was especially evident during the 2012 drought rally. Fearful of being accused of speculating on famine, big institutions shied away from commodities.
To be sure, these investors still own more than 1 million contracts in everything from grain to livestock to fiber. But many are increasingly wary, with PR concerns reinforced by new regulations put into effect in the wake of the financial crisis.
Big speculators, by contrast, came out with both barrels blazing. In just three months they bought almost 600,000 net futures contracts in the ag space, turning a modest bearish bet into a large wager on rising prices.
The rising tide helped lift all boats. Corn, soybeans and wheat all showed a strong correlation to the stock market, for example. This included commodities with strong fundamentals, and those where supply and demand were less bullish. The cattle complex posted record highs on a historically small herd. But the rally in soybean oil and wheat was more short covering than anything else.
Speculators' interest tends to be fleeting. Fund managers pile on the positions when charts are moving higher, and dump them just as quickly when chart signals turn bearish. The influence of the outside money is helpful now, but it could also increase volatility, and accelerate price declines when the party's over.
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Senior Editor Bryce Knorr first joined Farm Futures Magazine in 1987. In addition to analyzing and writing about the commodity markets, he is a former futures introducing broker and is a registered Commodity Trading Advisor. He conducts Farm Futures exclusive surveys on acreage, production and farm management issues and is one of the analysts regularly contracted by business wire services before major USDA crop reports. Besides the Morning Call on www.FarmFutures.com he writes weekly reviews for corn, soybeans, and wheat that include selling price targets, charts and seasonal trends. His other weekly reviews on basis, energy, fertilizer and financial markets and feature price forecasts for key farm crop inputs. A journalist with 38 years of experience, he received the Master Writers Award from the American Agricultural Editors Association.
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