Head of Commodity Strategy
Summary: The extraordinary temperatures seen this year, partly due to El Niño as it continues to develop in the equatorial Pacific, has created a very volatile year across the agriculture sector. Some areas have been hurt by high temperatures and drought while others have been impacted by too much rain, but overall a clear trend has emerged with the southern hemisphere suffering a bigger disruption than the northern, and it helps explain a widening gap this year between the performance of soft commodities - such as cocoa, coffee, cotton, and sugar on one hand, and the grain and soy sector on the other.
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“October temperature record broken as 2023 ‘near certain’ to be warmest year” was the headline in this recent article which sited data from the EU’s climate monitor. The extraordinary temperatures seen this year have partly been due to El Niño as it continues to develop in the equatorial Pacific. A weather phenomenon, explained by NOAA here, which tends to bring rain to South America and droughts to Australia and parts of Asia, and the result has been a widening gap this year between the performance of soft commodities - such as cocoa, coffee, cotton, and sugar on one hand, and the grain and soy sector on the other.
The softs sector is so far showing a 32% year-to-date gain, while the grains sector has fallen by 14%. Despite weather scares early in the growing season and concerns about Ukraine, a bumper crop has emerged following a strong growing season across the northern hemisphere. Lower wheat, corn and soybean prices have done a great deal to reduce inflationary pressures around the world, but dark clouds may still emerge into the southern hemisphere production season with hot temperatures in Australia and too much rain in parts of South America highlighting the different impact of El Niño which may grow in strength in the coming months.
The softs sector has experienced a much more challenging year so far with many of the products being produced across regions from West Africa to India and Thailand which have been exposed to extreme temperatures and with that loss of water and production. Examples being cocoa which trades near a 44-year high with this season’s Ivory Coast port arrivals remaining well below last season’s pace while sugar has reached a 12-year high, driven by port congestions in Brazil at time where India’s crop has been hurt by dryness, leading to export restrictions from the world’s second largest shipper. Furthermore, lack of rain in October due to continued impacts of El Niño could signal the country’s production problems will extend for a second season, limiting supplies through 2025.
The sharp divide between grains and soy contracts and the softs are on clear display in the below performance table, and while the overall impact on the global economy and consumers remain relatively low given price movements so far in key stables such as rice and wheat, the risk to production from rising temperatures across the world, leading to water shortages and more volatile growing conditions can unfortunately not be ruled out.
Frozen orange juice futures top the table below after reaching a record high last month above $4 per pound, more than 3X the average price seen before 2022 when orange groves were damaged by Hurricane Ian. In addition, more consistent damage has been caused by the citrus greening disease, resulting in the USDA forecasting a production of 20.5 million boxes in the 2023/24 marketing year, down from 41.2 million boxes produced in 2021/22.
Agriculture-related companies in the S&P Commodity Producers Agribusiness Index which is tracked by the iShares Agribusiness UCITS ETF trades down around 15% on the year, and by coincidence in line with the loss seen in the above-mentioned grains index. While an investment in food commodities risks amplifying the risk of even higher prices, an investment in companies involved with the sector can instead be part of the solution, as the industry tries to optimise production methods in order to address the growing threat of climate change.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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