Commodity Alpha Q3 2022 commentary

Market overview

Towards the end of the quarter the biggest concern for global markets, and commodity markets in particular, was the fear of a global recession. Higher interest rates across the world created some stress, while higher mortgage repayments, a devaluation of many currencies besides the dollar and a gloomier outlook have weighed on consumers. 

Previous slowdowns in the West have been offset by a bid from China, taking advantage of lower prices to fill stockpiles or inventory. However, this time China is unlikely to come to the rescue, as it struggles with its property market overhang and reduced economic activity from COVID-19 lockdowns.

Strategy performance (net of fees)

Commodity markets were pushed lower by macro factors such as the Federal Reserve rate hikes and inflation expectations. The strategy navigated this environment well as the ‘Russia-Ukraine war regime’ that was previously dominating commodity markets diminished. 

Since inception (May 2020): 64% (net of trading costs, service fee and performance fee - considering a performance fee for investing since inception but, since your performance fee will depend on your point of entry, your net returns will vary too).

Strategy positioning throughout Q2 2022

In July, the strategy performed well in the Softs complex, with a good short position in Sugar. Sugar had initially been supported by poorer weather expectations, however, pricing shifted lower when Petrobras reduced Brazil's gasoline prices. This implied that sugarcane mills would get a better return producing Sugar instead of ethanol, increasing supply expectations. The sell-off was fuelled by an announcement that India would bring more Sugar to market. 

Natural Gas, where the strategy was bearish due to high volatility signals, was the weakest performer. Gazprom reduced capacity in the Nord Stream 1 pipeline to 20 percent of capacity, having already cut it from 40 percent of normal levels.

In August, commodity markets remained volatile, with the market trading lower at the start of the month before rallying sharply. Adversarial weather conditions were a theme, benefitting the portfolio on the long side and hurting it on the short side, with most of the action in the Soft commodities.

The strategy was well positioned and capitalised on the price movement in Cotton. The dramatic price action came as the US Department of Agriculture (USDA) projected that US cotton farmers would harvest the least number of cotton acres in over 150 years. Droughts in the south and west of the country, in particular Texas, caused farmers to abandon fields at a record rate.

This month, the short Coffee position was worst as prices rallied sharply towards the end of the month, hitting a six-month high, on concern that excessive dryness in Brazil would reduce coffee yields. Inventories monitored by the Intercontinental Exchange (ICE) were tight, with inventories falling to a 53-year low.

During September, the market reassessed the probability of a global recession, triggered by Federal Reserve rate hikes and surging inflation.

The best position was a short position in Natural Gas.

Over the summer, Natural Gas markets were bid up by European countries competing with Asia to fill storage ahead of winter, as Gazprom reduced supplies via the Nord Stream 1 pipeline. Simultaneously, the higher prices of gas and electricity prompted demand destruction and substitution across industry, resulting in gas inventories building quicker than expected across Europe. Europe was targeting inventories to be 80 percent full by 1 November and will likely overshoot this target and reach 90 percent. This has reduced buying urgency over September and we should expect to see demand for Natural Gas continue to weaken, in the absence of colder-than-expected weather.

Performance was weakest in Agriculture, in particular Wheat where the strategy was short. A strong Wheat crop is expected over the 2022/2023 season; the Russian harvest in particular is expected to be large.