At a Glance
- Trade policy, U.S. soybean supply among factors shaping markets
If you haven’t seen a compelling investment story in agricultural markets in a few years, that may be about to change. Several fundamental and macroeconomic factors are converging to create a busier than normal summer season for ag markets.
On the supply side, a drought in Argentina cut soybean production there, and there’s dryness in the U.S. southwest. The U.S. corn crop is off to a record start, and for the first time in 35 years, the U.S. has planted more soybeans than corn.
Trade policy also affects the market, whether it’s discussions about reframing the North American Free Trade Agreement with Mexico and Canada, or disruptions in trade flows to China, which affect soybean and pork exports. These policy decisions have both a fundamental and macroeconomic influence on market action.
Attracting Global Participants
Agricultural markets also offer market participants a highly liquid, diversified asset class whose fundamentals don’t connect to equities or debt instruments. As the Federal Reserve normalizes monetary policy and raises interest rates, agricultural futures are an option to other alternative investments for buyside participants seeking an asset that’s uncorrelated to interest rates.
The convergence of these factors has led to strong growth in open interest – the number of current outstanding contracts — in agricultural products, which makes for deeply liquid markets, and is attracting global participants.
On June 19, a record 3.2 million agricultural futures and options contracts traded in one day at CME Group. On the same day, open interest reached over 10 million contracts. Participation from outside the U.S. is one reason for the growth in trading. A record 778,841 agricultural futures and options contracts changed hands outside of U.S. trading hours on April 4, nearly double the previous daily non-U.S. volume record set in April 2016.
Agricultural trading volume has grown 37 percent in the Asia Pacific region and 41 percent in the Europe, Middle East and Africa region since the beginning of 2018. In fact, through the second quarter, 19 percent of agricultural volume has come from outside the United States.
Going Long and Short
Buyside participants were active in agricultural markets in the 2004-2008 timeframe. These participants are returning, attracted by the combination of a strong fundamental and macroeconomic story along with the deep open interest and increased trading volume. On May 29, the number of large open interest holders – market participants with futures and option positions above reporting levels set by the Commodity Futures Trading Commission in agriculture futures reached a record 3,720, surpassing the previous record of 3,691 contracts set on May 1.
Rather than just utilizing long-only strategies, this time the buyside is using “risk premia” strategies, which allow them to go both long and short. According to the Financial Times, the “risk premia” funds have attracted about $20 billion in commodities investments since 2016. That’s a 15 to 30 percent increase in the past year versus $13 billion in commodities-focused hedge funds. The “risk premia” strategies usually involve spreads and include factors other than price to make trading decisions, such as following momentum, volatility and the pattern of prices for future delivery.
Volatility Still Low
Options implied volatility entered the season historically low, but has now seen a range of levels as unknowns like trade policy and weather have entered the marketplace.
As any ag market watcher knows, the summer can often lead to market-moving events. The June 29 U.S. Department of Agriculture (USDA) Acreage report, which documents how much land farmers devoted to corn, soybeans, wheat and other row crops, kicked off the summer season with news of the large soybean crop in the U.S. In addition to the other factors now influencing agricultural markets, weather variability always looms over the growing season and can increase volatility and trading opportunities.
Because the liquidity in the agricultural markets is deeper than it has ever been, these products will be well-positioned to handle increased order flow if a significant, market-moving event were to occur during 2018, making it easier for participants to get in and out of positions.
The factors driving the market today aren’t short-term influences. Trade policy discussions are likely to be drawn out and market participants’ interest in an alternative asset to equities and fixed income will be necessary as interest rate policy changes.
Compounding these policy factors is the timing of it all. Ag markets are heading into what is traditionally their most active period. Not only does the growing season continue, September brings the beginning of harvest and its own set of potentially market-moving events. Ag markets, always busy in the summer, are set up to remain a critical macroeconomic factor for at least the remainder of 2018.