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STORMY WEATHER AHEAD FOR DBA

|Includes: PowerShares DB Agriculture ETF (DBA)

We've been through a few stormy patches in the past 2 weeks in all markets. DBA is down 9% since the beginning of the year and is currently resting at the bottom of a trading range initiated in March 2009. It may break its support level on the downside particularly if the US dollar remains strong.
Even before the Greek crisis and the resulting upward surge of the dollar, agricultural commodities have not performed well. The ETF certainly offers you some diversification from equities but the trend is likely to be the same at least for the time being.
Most retail investors are attracted to commodities ETFs on the premise that greater affluence in emerging markets will result in higher prices for foodstuff. This is likely to be true but maybe not in the short term as we are facing large inventories for grains which represent close to 50% of DBA's holdings. Planting in the US is currently running ahead of schedule, forecasting another bumper crop while a potential slowdown in the the global economy by the end of the year would weaken demand.
For the long run things are sunnier. The USDA in its February report for the next ten years projects prices for grains to remain high and higher prices for livestock following the current adjustments due to weaker demand in the past 2 years.
For the coming months a serious constraint will be the behaviour of the US dollar. While the inverse correlation to the US dollar does not normally apply it has in the past 6 months. So the current strength of the U dollar does not bode well for commodities.
Many investors are also looking at commodities as an hedge against inflation. The immediate threat is likely to come from deflation rather than inflation particularly in developed countries. The Greek crisis and its spill over to the rest of Europe is highly deflationary. Inflation will eventually come but not in the next 6 months. Investors should also consider that commodities ETFs are financial instruments and not a pure play on physical assets. For instance, DBA's total assets almost equal the value of the US yearly production of its underlying commodities. Financial speculation on commodities may thus result in sharper moves in futures markets than for the spot price of many of these commodities. That is why the correlation of the commodities index CRB with the S&P500 is 0.66 for the past year. DBA's relatively poor performance during the same period gives it a correlation of -0.28. So in that sense DBA achieves the diversification purpose.
DBA is a future-based ETF. It rolls its contracts according to a predetermined calendar so the fund may lose if the market is in contango. The worst example of this is UNG. In the case of DBA it has the advantage in being diversified into 11 commodities futures.
If you are already long DBA, you will need to be patient and sit on your investments for a while. For other investors, the coming months will give you a better entry point.




Disclosure: Long DBA