The Wonders -- and Risks -- of Extreme Leverage

Hey GB, do you think that leverage and futures contracts have driven the price of soft commodities, like wheat, over that last 6 months?
Are the agri-commodities in a bubble now, that will burst later this year, or will these things stay at present levels permanently?

Yes to the first question.
To the second no, we are not in a bubble in agri-commodities and probably have another few years to run in that sector (maybe even a decade)

Cheers. Im going into agri commodity etfs now as a medium term play, but prices seemed a little bubblicious. Totally missed the bull market of the last six months.

Are we in the beginning of a bubble?

Personally I don’t see how the fundamentals have changed sufficiently to support the demand side argument.

The demand fundamentals for commodities have changed. 1.3 billion people in China now want to eat meat, dairy and wheat products. In the past, when China was poor, they used to just survive off rice.
Same story across latin america. People down there are eating more and better now. Demand is growing big time.

Still because of heavy buying of commodities futures its hard to know if there will be a price fall in the next few months or not.

What will be interesting in terms of agri-commodities is how the farming season of the major grain exporters pans out.

Some caveats on current prices: the price of pork in China is disproportionately high at the moment due to slaughtering out to eradicate blue-ear disease. This led the Chinese to import more pork. A lot more of it. The prices of cereals has been affected by poor harvests for a few years in major grain exporting nations (particularly Australia). The price of corn has risen as a result of US moves to increase biofuel purchases, leaving less to export. The price of food oils has also increased due to demand for biodiesel. The prices of many meat and dairy products are directly linked to the price of cereals - feed for animals.

As meat is an expensive way to produce carboyhdrate (in the form of fat) and protein it takes more cereal to produce the same food quantity of meat (something like 4x?). If the change in chinese eating habits continues to be supported (by retained standards of living and state subsidy) overall demand for ‘meat’ should remain higher.

However, intensive rearing, returning pasture to tillage, removal of set aside and generally more efficient land use will increase supply.

I suspect a bumper year of Australian or Canadian wheat production would see some of the froth blown off the commodity markets. My own amateur feeling would be that too much hot money has already moved into agricultural commodities. The same thoughts in the 'seventies posited the same old tired malthusian arguments about limited land supply and productivity. As with much of the peak oil debate, the problem is not the amount of food that can be produces, but the price at which it becomes attractive to do so.

PS. The chinese are unlikely to consume dairy products as many are lactose intolerant. There is no history of using dairy products.

Australia wheat output to increase 65% in 2008 YoY … ?id=381725

World wheat production to rise

Nice post there Yogan. Thanks for that. Ill put a stop loss on my commodity holdings just in case of bubble deflating.

Yeah, I was simplfying things there. But demand for dairy is growing massively because of India importing milk powder. Indians do consume dairy and theyre consumption levels are growing.

Not sure how quickly it will happen - I believe the Oz projections are 2008-9.

Canada will come in August/September 2008 as will Russia.

(for wheat).

A stop-loss if probably a good idea anyway, as sentiment is a fragile thing these days! If there is speculation across commodity classes, deflation of one bubble may infect the others.

good post. i have been riding the rally for a year and here are some thoughts:

(1) short term cereals and broadleaf crops (eg soya) are a play on the weather. unless you have some special insight there :wink: you probably want to stay clear. also feels like futures are being squeezed. i have sold out of wheat.
(2) ag commodities are a long-term play. consumption change, population growth and inevitable growth in biofuels as explained by yoganmahew. energy input (machinery, fertiliser) costs have also supported the recent price moves.
(3) the growth in yield of ALL major crops has been incredible since the 60s. however physical limits are being reached according to agronomists.
(4) there are things going on that look like … well… climate change. For crops that basically means more water stress. rainfed agriculture gets riskier. uncertainty helps prices. some crops need high levels of climatic stability (e.g. coffee).
(5) finally the price action over the past year is a big red flashing light to fund managers to include softs in their portfolios and for governments to increase stragetic reserves.

the “fundamentals” are good. “buy on dips”.

oh dear, where did i hear that before?

Strangely enough Yves Smith has a piece on commodities today.

Chart of commodity prices: … ture+7.png

What surprised me was the ag commodities, e.g coffee down 9.6%, sugar down 11%, wheat down 5%.

I don’t believe this can be explained either by the US economy or some magical long-term forecast of crop yields. So that leaves profit taking or an unwind.

My bet is on an unwind - someone is seriously looking for capital. (Actually, I suppose that’s no different from profit taking!).