Conclusion: While we will continue to pick our spots across the commodity complex, broadly speaking supply data points continue to support elevated prices, which in turn drives higher inflationary readings globally.
There is a well know adage when it comes to advice in the stock brokerage industry, which is:
“Advice is the only commodity on the market where the supply always exceeds the demand.”
While this adage no doubt is true, we believe that the commodity markets themselves may be an area where supply continues to be constrained, which is supporting higher commodity prices.
As we wrote on January 4th, 2011:
“Interestingly, despite our view of slowing growth into 2011, it seems that we are seeing evidence of supply constraints across the commodity complex that are poised to drive commodity prices higher in the face of a sequential slowdown in growth. Higher commodity prices and slower growth mean one thing: stagflation.”
Since that note, the agricultural commodities have continued to increase in price. In fact, the commodities we highlighted in that note specifically are up as follows since January 4th, 2011:
- Sugar +0.9%;
- Soybeans +1.8%;
- Cotton +14.1%; and
- Rice +4.6%
In the meantime, we continue to collect global data points that highlight supply constraints in the commodity complex, specifically:
- Australian authorities expect coal production to be down 10% in the coming year due to the flooding in Queensland;
- Corn inventories in the United States are the lowest levels since 2007;
- Ivory Coast is limiting exports of cocoa;
- Based on the latest reports, US cow and bull (non-fed) slaughter for the past seven days (Jan 13 - Jan 19) was 131,000 head, about 13,000 head or 9% lower than the same period a week ago and also 10.9% lower than the previous year;
- A looming shortage of milk stares Kenya in the eye. The North Rift region, which produces 80 per cent of the country’s milk for sale, has registered a 40 per cent drop in supply;
- Indonesian exports of coffee are down year-over-year and Brazilian production fell sequentially from November (3.5MM tons) to December (3.15MM tons). As well, Colombia’s largest growing province is expected to post lower production this year due to less sunlight;
- The Uzebekistanian cotton crop is expected to be down 5% year-over-year; and
- Natural gas inventories in the U.S. continue to decline and are now only 1.9% above the 5-year average.
The last point on natural gas is an important one to highlight. The bear case for natural gas is well known and, in the long term, we support it. In fact, in the longer term we believe investors may not be bearish enough on natural gas supply growth (which is driven by an acceleration of horizontal drilling and shale projects) in the United States. In the short term, price is driven by fundamental changes on the margin.
As it relates to natural gas, the primary change on the margin is rapid declines in the way of U.S. inventories, which we’ve highlighted in the chart below. In the last month, natural gas is up almost 10%, which is the third best performing commodity we track. (Only orange juice and milk are ahead of natural gas.) The drive is colder than expected weather in the U.S. and as a result natural gas has gone from being well oversupplied to being marginally oversupplied. Two weeks ago natural gas inventories were 5.8% above their 5-year average, which declined to just 1.9% last week. Still oversupplied, but less so.
As always, what happens on the margin drives prices.
Daryl G. Jones