By Tony Daltorio
Commodities may be the most fascinating of investments. No worries about quarterly earnings or a company cooking its books with commodities. But investors do have to be alert to a multitude of factors, including the weather, geopolitics, and trends in supply and demand for a specific commodity. All of these factors can sometimes lead to a good amount of volatility in the price of a particular commodity.
Today, we’ll look at two commodities where the fundamentals look good right now, but investors should keep an eye on their potential volatility.
The first commodity investors should consider is the most heavily-traded commodity in the world: oil. Its importance to the global economy is well known to investors and, thanks to geopolitical concerns in the Middle East and elsewhere, it is also one of the most volatile commodities. However, in recent years, that volatility has had an upside bias to it, with the benchmark Brent crude oil futures contract usually trading above $100 a barrel.
One of the main reasons behind this is surprisingly resilient demand growth led by the emerging markets, despite the global economic slowdown. In August 2012, the International Energy Agency revised its projection upward for oil demand growth for the year to just a fraction below the previous 10-year average of 1.1 million barrels a day. This steady demand has pushed Brent crude oil well off its lows in a relatively short time. It has risen nearly 30% over an eight-week period to about $117 a barrel. The price movements can be tracked via the United States Brent Oil Fund (BNO).
Another longer-term reason for investors to consider oil is the change in Saudi Arabia’s attitude toward oil prices. Once consider a “dove” pushing for lower oil prices, the country has now seemingly joined the “hawks” like Venezuela in targeting $100 a barrel as the base price for oil.
The reason behind this change is the Arab Spring. Like other countries in the Gulf region, Saudi Arabia has increased public spending sharply on items like food, fuel and housing in an attempt to appease its citizens, some of whom are growing increasingly restive. In 2011, the kingdom raised its domestic spending by $129 billion – the equivalent of more than half its oil revenues.
Now the International Monetary Fund and other analysts estimate that the kingdom and other Gulf countries need oil to be selling at least at $80 a barrel for the governments to balance their budgets. This is up, in Saudi Arabia’s case, from a mere $25 a barrel a few short years ago. So in effect, traders going long oil now have many OPEC countries in their corner putting a floor on the downside, leaving the possibility of upside profits from the volatility.
The second commodity for investors to consider is one vital to the global food chain. Corn is used as a food ingredient for human consumption, and also as a key ingredient in animal feed for the meat and poultry industry. In the United States, corn is also used to make biofuel (ethanol). In fact, roughly 40% of the domestic corn crop is used to make ethanol.
As with all commodities, one must look at both supply and demand. Demand for U.S. corn remains strong globally, as can be seen by the recent purchase of corn by Mexico, the biggest single-day purchase of corn in two decades. But the real story in corn is on the supply side.
Agricultural commodities such as corn are more difficult than oil to hold as a long-term investment, since their price is almost wholly dependent on the weather. A great growing season can easily be followed by a terrible one, affected by El Nino and other global weather patterns, resulting in great price volatility.
The influence of weather can be seen this year in particular. Only this spring, analysts were predicting a record corn crop in the United States, pushing corn prices down to below $6 a bushel. But if one looks at how the year has unfolded, the U.S. 2012 growing season can only be described as a disaster.
The worst drought in 50 years in parts of the United States destroyed one-sixth of the nation’s corn crop in a month’s time as farmers abandoned their corn fields. According to the U.S. Department of Agriculture, roughly 9 out of every 10 acres of corn are sitting on land affected by the ongoing drought. And about half the U.S. corn crop is categorized as poor or very poor, the worst seen since the 1988 drought. These poor conditions have pushed corn prices to all-time highs at $8.4375 a bushel range recently, although the price is down about 5% from that level currently. The price of corn can be tracked through an ETF such as the Teucrium Corn Fund (CORN).
The Department of Agriculture now estimates that the U.S. corn crop will come in at only 10.8 billion bushels, down by 2.2 billion from its projection of only a month prior, adding to the volatility. Why is corn so important? Because the fate of the U.S. corn crop sends reverberations around the globe. Last year, U.S. farmers grew 35% of the world’s corn crop and exported a total of 40% of the world’s corn traded on the markets. Investors can expect more volatility this year as the estimates for the crop are changed again and again due to the weather.
As for the next crop year, the high prices for corn will lead to U.S. farmers planting perhaps a record number of acres with corn. Only Mother Nature knows if that leads to a bumper crop or another disaster like this year. One point to keep in mind is that weather patterns like El Nino tend to linger for a longer time than most expect.
It’s certain that oil and corn prices will remain volatile for the foreseeable future. Since both are so important to the global economy, they are well worth considering after investors do their homework and due diligence into ETFs such as BNO and CORN.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.