Grains freed from macroeconomic forces

by Morton I. Sosland
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In a world that had become used to attributing commodity price moves to macroeconomic forces, developments this crop year in wheat and other grains have provided support for those who see fundamental supply-demand changes as the main drivers of commodity prices. This year’s dramatic climb in wheat, corn and soybean prices, it is universally agreed, came about because disastrous drought and heat curtailed yield prospects, turning what had been a bright promise at the season’s start into a calamity as weather-related damage unfolded. Few, if any, commentators have blamed the Eurozone financial crisis, fluctuations in foreign exchange or interest rates, even erratic shifts in consumer spending for what happened in the record-setting grain price moves that defined 2011-12 and may define 2012-13.

Ruling out these broad economic forces as having little, if any, effect on grain prices is significant change from views that had been gaining force in recent years. At one point, before this season’s explosion produced its astounding price moves, the viewpoint was being heard from numerous respected market students that supply-demand hardly mattered in determining where grain prices may be heading. All too often it became easy to make adjustments in either the supply or demand side that made these of scant consequence, that instead it was insisted, focus should be on the broad economic currents that for the most part were not previously considered in grain analysis.

This thrust in analyzing price moves was reinforced by what was happening in global equity markets, most notably the amazing rise in correlation among stocks. Rather than relying on how each company was doing from a profit and loss point of view, attention centered on macroeconomic factors that affect overall market trends. This resulted in the time when the correlation between the S&P 500 stocks approached 90%, which was three times the average of the prior 50 years. Even the pronounced difference between the performance of equities in developed countries and emerging markets nearly vanished to reach 80%. These moves both explained and accounted for the rising importance of passive, or index, trading. Stock selection gave way in the same way commodity moves were seen as unrelated to what was happening in individual markets.

How this change came about initially and how it has been reversed this season provides helpful insights into how markets are driven. Not too long ago, grain price moves in any direction were blamed on actions by the funds established in fairly recent periods to allow investors to take positions in commodities. These multi-billion-dollar funds were established to offer investors the chance to own commodities as a new asset class like equities and fixed income. Ownership in a fund invested in commodities was promoted as a way of diversifying.

Even as experienced commodity traders looked askance at the idea of the public buying commodities through these entities with the same goals as equity purchases, these funds were hugely successful as measured by their massive size. The long and short patterns of these funds, largely a reflection of how individual investors were buying or selling the funds, became powerful forces. Since investor attitudes mainly reflected moves in equities and assessments of the general economy, the results reinforced the overriding influence of macroeconomics.

It has required one of the worst droughts in American history to show how a supply change of this magnitude can bring a radical shift in the forces accounting for price moves. Not only have the grains performed differently from most traditional investor products like securities, but the pattern of commodities tending to move together has also been shattered. At a time when grain prices were soaring, non-grain agricultural markets tended toward weakness. In the same period, world oil prices were falling at the time grains were sharply advancing. This is a price trend divergence that hopefully has halted tendencies to ascribe moves in wheat and crude oil to the same forces.