How To Use Commodity Spreads During Geopolitical, Inflationary, And Weather Chaos
Summary
- What are commodity spreads and how to use them.
- Where are some of the major weather extremes presently?
- A look at historical May commodity seasonal trades.
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What are commodity spreads to offset trading risks?
The stronger U.S. dollar on rising interest rates and inflation risks is beginning to take its toll on some commodities. For example, the price of gold collapsed by more than $100 last week, and crude oil prices by more than $20. Plus, there has been some profit-taking in corn and soybeans, following a stellar winter rally on South American weather problems, the Ukraine War, inflation, etc.
However, global weather problems continue due to a combination of Climate Change and the 2nd year of La Nina. This will offer many trading opportunities in commodities from natural gas (BOIL) to corn (CORN), wheat (NYSEARCA:WEAT), coffee (JO), sugar (CANE), and much more.
One commodity that is most affected by climate change is the coffee market. However, for the most part, over the last 6 months, I was in the bearish camp in coffee due to an improvement in the Brazil crop, the stronger dollar, and demand concerns due to COVID and now the war. Here is an article I wrote, however, about potentially some new weather concerns for the coffee market. Using spreads in the coffee market does not make sense, as it does so in the grain market. I like using options instead.
To offset geopolitical and inflation-related risks in commodities, it is sometimes useful to use "commodity spreads."
This video I prepared on Sunday (before Monday's wild price move in grains, again) discusses what commodity spreads are, and particularly focuses on grain spreads during spring and summer weather markets.
Using commodity spreads to offset trading risk (Weather Wealth Newsletter)
Recent extreme weather events
Two blizzards in the northern Plains have slowed corn planting and potentially spring wheat, while the drought in the southwest has resulted in the worst wheat crop in years from Nebraska to Texas. The Texas drought may also add even more bullish enthusiasm to an already "out of control" cotton market (BAL). The good news for farmers in Nebraska, Kansas, and Oklahoma this week, is desperately needed rainfall.
Here are just a few of the most recent extreme weather events.
1) Near-record U.S. tornado season that I began forecasting in March. Check out last week's tornadoes in Kansas with this incredible video, here.
Andover, Kansas tornado (Wichita Star)
2) Record-breaking heat in India. This is not a factor for commodities like sugar, cotton, and others until the summer, but a lower Indian wheat crop is noted. As Reuters reported:
Parts of India recorded their highest average temperatures on record in April, and the scorching weather is expected to stretch into May, the India Meteorological Department (IMD) said on Saturday. India and neighboring Pakistan have been suffering from extreme heatwaves this year, melting pavements, forcing school closures, and triggering health and fire alerts. Northwest and central India recorded average maximum temperatures of 35.9°C and 37.78°C (96.6°F and 100.0°F) respectively in April, the IMD Director-General told reporters.
Weather Wealth newsletter (Reuters News)
3) The western U.S. megadrought: This has added to the bullish spike in natural gas (UNG) due to concerns over less hydropower in many states.
Historic western drought (Bloomberg)
4) More flooding for Australia. This could impact grain planting due to La Niña and what is happening in the Indian ocean with the Indian Dipole.
Floods in Australia coming again (www.Bestweatherinc.com)
So when it comes to spreads, the weather will have a huge impact on grain farmers, hedgers, and traders in the weeks ahead. Just some of the many questions I will be answering from Weather Wealth clients are:
1) Will corn planting delays continue and if so cause less corn acreage to be planted and more soybeans? If so, this will affect the corn-soybean spread deeper into May.
2) The easing of the Plains wheat drought I began talking about very early, last Monday, could have implications with respect to KC vs CBOT wheat spreads and wheat vs. corn spreads. But how do you play the weather game? Will the weather in Europe and Russia improve for wheat? It is not just the U.S. wheat crop the trade is watching.
In the meantime, while many of these seasonal trades are not weather, here is a partial list of the most successful commodity spreads (multiple markets) over the last 15 years. These commodity spreads do not always work in times of geopolitical and inflation concerns, but the majority of these should work in the weeks ahead.
LIST OF HISTORICAL SUCCESSFUL MAY COMMODITY SPREADS (MOORE RESEARCH GROUP)
Conclusion
Climate change and La Nina will continue to result in huge weather volatility this spring and summer. You combine that with inflation out of control and the Russian-Ukraine war and the best way to trade commodities is to use spreads.
Jim Roemer
This article was written by
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