Tuesday, February 19, 2008

What to Make of the Soft Commodity Rally

What to make of the '08 soft commodity rally? Things have happened so fast - even I'm not sure in the short term. I still believe that the long-term case (next 5-10 years) is firmly in place. Rising demand and limited supply will take time to fix - and by that time, most of the soft commodities (sugar, coffee, cotton, cocoa, etc) should make all-time highs.

In the near term, things are certainly exciting, but a bit dangerous. The softs are up big this year - their prices are being driven hard by investment funds and speculators piling into these markets.

Let's take a quick look at the news to get a view of the fundamentals of my three favorites: coffee, sugar, and cotton.

Brazil just had a disappointing harvest - off 21% from last year, due to dry weather during the flowering season. Remember back in Sept/Oct, when coffee rallied on the dry weather - then dropped when it rained. Well, turns out it was not enough rain after all.

Brazil is far and away the world's largest coffee producer - so as Brazil goes, so do coffee prices generally. However there are also speculations that Vietnam and Colombia will also report sub-par harvests.

World demand is going up, as the world turns more and more "American". Keep a close eye on China and the rest of Asia, as a very small but growing coffee market continues to gain ground on tea, the traditional caffeinated drink of choice.

Could there be setbacks? Of course. However, the fundamentals are setup for us to see a super spike in coffee over the next 5 years - and I believe we'll see $2+ coffee at some point.

After sugar made its run at 20 cents a couple of years ago, guess what happened? A ton of sugar came on the market. Inventories of sugar went up - and in concert, the price went down - all the way below 10 cents again.

Well sugar is on the move up once again - now climbing above 13 cents. According to investor Felix Zulauf, the price of sugar still lags below the cost of production in the two largest sugar producing countries: Brazil and India.

The story of sugar is, and has been, its use as a biofuel in Brazil. Last time I checked, oil was still high - so I have no reason to suspect the demand of sugar as a biofuel to do anything but increase. Remember, sugar is the only economically viable biofuel without subsidies.

The price is going higher at some point. This may be the beginning of the move. Be careful though - as there is still a fair amount of inventory on the market to work through. And if the speculators head for the exits, the price could take a hit. All setbacks will likely be temporary though, presenting buying opportunities for those not yet long.

Now this is one of the few commodities that has done absolutely nothing since the bull market started! This excites me. It's still cheap, and it has to move at some point - and we have a lot of upside ahead of us.

Of course, there are a lot of smart people that realize this. Fundamentally, cotton acreage will continue to suffer - as farmers in the US South and other places plant higher priced crops (basically anything at this point) in favor of cotton. Supply goes down, demand is rising, and prices skyrocket - the beauty of a bull market.

Demand for cotton is increasing at a breakneck speed in the places that matter most - China and India. Demand is decreasing in the developing world, but the increase in China and India is now enough to offset this decline. Expect cotton to spike sooner rather than later.

This article was published by Seeking Alpha

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