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Some believe that inflation is a good reason for investors to buy and hold commodities. They will argue that owning physical products (or futures on physicals) will provide a return, as these assets will be chased by investors who believe they will appreciate. Others would suggest increasing interest rates (usually occurring when inflation occurs) will reduce the purchasing power of buyers. Therefore, demand will be reduced as the cost of goods is higher, not to mention the cost of money to hold commodities.
Both probably have their place and time. If you are an Argentine farmer in recent years, holding onto soybeans made sense. Once converted into cash, the farmer is now holding a currency that has devalued as skyrocketing inflation makes for reduced purchasing power. On the other hand, holding physical commodities can be risky if consumer demand slows, whether real or perceived (perception does play a big role in the future value of goods).
In challenging economic times, buyers have a tendency to buy on an as-needed basis. Long-term buying is forgone in the hope that buying only what is needed now will allow for prices to decline later. The futures market is the centralized auction place for futures contracts on commodities. When traders sell the deferred futures contracts, they expect that future supply will be more plentiful, either through increased production, reduced demand, or both. When deferred contracts reflect lower values, this is called an inverse carry market. Buyers are buying deferred contracts only if future prices are lower than nearby prices. For producers, the key is to recognize that holding inventory in an inverted price environment is a risk. The market is signaling it wants your product sooner than later (usually due to tight supplies). So how do inflation and interest rates come into play?
Higher interest rates increase the cost of borrowing. Holding physical commodities becomes more expensive. Since interest rates began their ascent last June, going from near zero to what is expected now to be near 5% (4.83% as of this writing), commodities have seen managed money exiting long positions. The war, post-pandemic spending, supply chain disruptions, and weather may have all played a part in commodity prices reaching multi-decade high levels this past year. Yet, since interest rates began moving higher, the number of positions held by managed money has been in a steady descent (reflected in the weekly CFTC Commitment of Traders report).
Holding highly-valued commodities costs money. Additionally, as demand for goods fades (due to high prices), sales of physical commodities rise (the fear of lower prices creates stronger selling), which can further pressure prices and create liquidation in the futures market. End users become reluctant buyers, changing from a mentality of making sure they have ownership to only purchasing what is needed. The old saying, “high prices cure high prices” has merit. Perhaps more important is that high prices coupled with rising interest rates accelerate the decline of high commodity prices.
Editor’s Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
Disclaimer: The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices have already factored in the seasonal aspects of supply and demand. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing and TFM refer to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. SP Risk Services, LLC is an insurance agency and an equal opportunity provider. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with all three companies. SP Risk Services LLC and Stewart-Peterson Inc. are wholly owned by Stewart-Peterson Group Inc. unless otherwise noted, services referenced are services of Stewart-Peterson Group Inc. Presented for solicitation.
About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.
