Positioning across the agricultural markets.
Today’s short comment is on the extreme levels of positioning in the agriculture and soft commodity futures markets. The tables and charts below are based on the main US agricultural markets *.
*ICE US Cocoa, ICE US Coffee, CME Corn, ICE Cotton, CME Wheat (SRW + HRW), CME Soybeans, Soymeal, Bean Oil, ICE Sugar No.11
Commercial Positioning
One thesis is that with the trade (commercials such as merchants, end-users and producers) have a record large short position in both net and gross terms. This in a backdrop where overall prices, whilst high, are nowhere near record high prices and bank financing becoming harder to come by and more expensive. In chart 1 we see that the net commercial position is at 100% of the maximum. The light blue histogram represents the % of the prior maximum. So a position that was 100% of a maximum in 2008 would be a different number to a position now. This way we can see the evolution of positioning in an environment of larger open interest generally across most markets.
Chart 1
In chart 2 shows the gross commercial position in USD terms and in MT. This is getting stretched on both metrics.
Chart 2
The bullish thesis is, if the agricultural market complex takes another leg higher what is the capacity if the commercials to hold these positions? Can the speculators do a WSB on Gamestop to the commercial participants? As you can see from the table below some of the position sizes in terms of Standard Deviations from the mean are significant.
Table 1
Managed Money Positioning
Chart 3
On the other side of the equation are the speculators measured by managed money. The net long positions are large in metric tonne (MT) and USD terms. However, with the size of the USD position is not as high (on a relative basis). This could leave room for positions to be added, speculators often manage portfolios to a USD notional basis not a volume basis. One caveat is exchange limits. These restrict the amount of futures (in lots) a speculator can hold within each market. So there are some market constraints to positions getting a lot larger.
The speculative short position is almost non-existent across most markets in the complex. The low number of speculative shorts is one result of a change in the market participants. Discretionary trading based on fundamentals in agriculture has had terrible performance in the past 5-7 years so less participants to ta ke the other side of the trade. In addition, over the last 5 years both CTA’s and Risk Premia participants have increased their allocations to the agri/softs markets. Most markets in this analysis have moved from being in carry (contango) to being inverted (backwardated) at least for the first 3-6 months of the calendar. This partly explains why positioning is getting remarkably high in markets like soybeans and corn but relatively benign in coffee and cocoa.
Chart 5
Swap Dealer Positioning
Usually the least looked at sector with the CFTC COT Reports. The banks (and some large non-bank corporate institutions) are not perceived as market movers. However, this is where a large portion of risk premia sits as the banks write OTC products that provide the return stream of various carry or momentum strategies. Pensions finds and similar styles of institutions then invest in these products.
Chart 5
In addition, speculators, asset managers and trade houses use Swap Dealers to circumvent exchange limits if they already are at an exchange imposed maximum. Commercials use swaps at time to manage liquidity by using a credit line to fund the initial and variation margin.
What is interesting here is the size of the short position the Swap Dealers hold and how quickly it has grown. This is shown in Chart 7 over leaf.
Chart 6
Chart 7
Macro Risks
USD
If we see a bounce in the USD back towards 94-95, that will weigh in risk assets and likely induce some commodity related selling. Causes of this could be extended lockdowns in Europe and the US into Q2 as vaccine roll out is slower than anticipated. If the USD weakness accelerates this could be very bullish for the complex. Ultimately my view is the USD is weaker in 6-9 months against most EM but we could see a shorter term pull back in risk sentiment.
Trade
At the moment China is buying a lot of US based commodities such as soybeans, corn and cotton. If this slows due to trade tensions then this could reduce the bullish US fundamental story that has been a strong tailwind over the past 3-4 months.
Conclusion
This makes for an interesting next couple of quarters. If markets sell-off then it should relieve the commercials and the swap dealers from their shorts and allow them to get positions under control for the balance of the year. Looking ahead, assuming normal weather and high prices you are going to have a lot of production to be hedged in the US, Canada, Brazil, Argentina, and Australia. If demand remains strong, supply in South America disappoints and the USD remains weak then the natural hedgers could be under a lot of strain.
Chart 8
For those who do not trade the underlying futures markets the DBA ETF by Invesco is one way to get exposure to the sector.
