Will Commodities go Back to Trading Fundamentals After Fund Wash Out? Are the Highs in in the Grains?

The last few weeks have been rather brutal for many of the commodity markets as grains, cotton and others have seen a selloff from historical highs.    For several months hedge funds bought commodities as a hedge against inflation, but the last few weeks they entered a massive liquidation phase on recessionary fears tied to the Fed’s aggressive rate hikes.  In fact, the agricultural markets were driven more by money flow at times than fundamentals. 

A JP Morgan Chase commodity strategist says about $15 billion dollars moved out of commodity futures markets just during the week ending June 24.   It was the fourth straight week of outflows, bringing the total for the year to about $125-billion.  That's was a seasonal record that tops even 2020.

Brian Grete, Pro Farmer says, "We’re seeing the funds get out.  The past of least resistance is down and that means sell and kind of ignore everything else.”

The macroeconomic picture spooked the hedge funds as the inflation bubble bursts and recessionary fears climb. DuWayne Bosse, Bolt Marketing says, "They just decided I don't want to be long anymore, I think the recession fears are really starting to spike higher."  

Brad Kooima, Kooima Kooima Varilek adds, "The money manager does he want to throw money at something like that when there's probably something that in his view is a safer place to ride out a recession, like an interest bearing instrument perhaps?"

Funds liquidation also pulled wheat prices down to pre-war levels.  Mark Schultz, Northstar Commodity, says, “I think the worst of them all was quite frankly has been the last two weeks of the complete destruction of the wheat market and wheat pretty much led this market to the upside and its now leading it to the downside.” 

So is speculative selling in commodities done?  Maybe short term, but analysts say longer term it may depend on future Fed action and recovery in the equity and energy sectors, even cryptocurrencies.  Ted Seifried, Zaner Ag Hedge, says, We’re worried that mismanagement is going to cause this recession to get quite a bit deeper and that things like crude oil that are just now breaking out to the downside have a lot more downside pressure to go and that’s going to lean heavily on agricultural markets as well.”  

Grete adds, "But the fear now is that the Fed pushes too hard, even as inflation starts to back down and then we slow down the economy and we’ve already seen indication that we are slowing the economic activity and then you get into periods of extended recession potentially."

But is the U.S. in a recession?  This June Fed minutes indicate they’re looking at further rate hikes this year to tame inflation and are optimistic they can it without sending the economy into recession.  But is it already too late?  Ernie Goss, Creighton University Economist, says, “We’re either in a recession or we’re very close to it.  The Atlanta Federal Reserve announced just last week that we are in a recession. They said that their indications are their readings are quarter 2 GDP was negative and combine that with quarter one’s GDP growth that was also negative and those readings alone would tell you we are in a recession."

Other key indicators include equity indices moving into bear market territory and an inverted curve on Treasuries.   Goss says, "The stock market is telling us hey this is not good, the bond market as you said negative yield curve, that’s the short term rates are higher than the long term rates and of course that’s not good.” 

Plus a selloff in certain commodities generally provides an early clue.  Darren Frye, with Water Street Solutions, says,  "Well cotton and copper are two of those leading indicators and they would tell you definitely we’re contracting this economy, we’re headed for a recession."  

Goss doesn’t think a recession will last long and agriculture will be more insulated.  However, demand destruction is possible, especially if the U.S. dollar stays at 20-year highs.  He says, "What’s happening there is the value of the dollar is going up, up, up and particularly against the Japanese Yen, even against the Euro the dollar is gaining strength and that’s not a good thing if you’re trying to sell U.S. goods."

Dr. Roger Cryan, American Farm Bureau Chief Economist notes, "A recession effects demand for everything potentially and that includes food at both ends of the scale."  

So does this mean an end to the bull market or is it just taking a pause?  And what will it take to bring speculative buying interest back into the commodities?

Grete says, "It might be that prices just get cheap enough where they look like a value buy again.  It might be some macroeconomic event, it might be some weather event, something like that. But something is going to have to flip the switch."  Frye agrees, "It would have to be something big like QE or Russia or something around crude oil going to $180 or something like that but short of that I just don’t see how we get a rally other than one to sell."

Until then some commodities like grains and cotton may have put in their highs for the year. 

As far as the Fed action, their June meeting minutes released on Wednesday indicate they’re poised to raise rates in July by either .50 to .75 points.  And further action is appropriate if elevated inflation pressures were to persist.   

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