Lex: Soft commodities

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There’s soft, and then there’s limp. Investors have made a pile of hard cash from oil, gas and metals. Until recently, though, soft commodities such as soybeans have lagged behind.

Commodity bulls smell an opportunity. The argument is familiar, and valid up to a point. Having sucked in all manner of industrial raw materials to feed its factories, China’s increasing affluence will lead its burgeoning middle class to guzzle ever more grain-fed beef and coffee.

Beware the supply response. Unlike oil wells, crops are renewable. A waving field of corn in one’s back yard is also much less objectionable than, say, a lead mine. Even sugar, a rare star performer among soft commodities due to its role in producing biofuels, is vulnerable to vast swathes of fallow Brazilian land being turned over to production.

Reading the softs market is also difficult. While energy and metals markets usually exhibit strong ties to movements in interest rates and industrial production, softs are also buffeted by seasonal factors.

Successful speculation in softs is also more dependent on volatile spot price movements. Short supply response times mean little premium for near-term stocks, keeping forward prices above those for immediate delivery. That precludes positive roll yields; when near-term prices are higher than longer-dated prices (known as a backwardation), investors earn positive returns by rolling futures positions forward.

Asian demand may push some agricultural forward markets into backwardation within the next year. But Deutsche Bank says that, since 1972, that has occurred only 20 per cent of the time in corn and 28 per cent in wheat. Lower liquidity in the softs markets, relative to those for energy and metals, also makes them more susceptible to the gyrations of hot money. Tread softly.

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