Japan's devastating earthquake and tsunami barely caused a ripple in North American equity markets. In fact, stocks rose in anticipation of all the lucrative reconstruction activity that will follow in the wake of the cleanup. But the same could not be said for grain prices.
Wheat , corn , soybean and rice futures all plunged, as the bad news from Japan piled on top of a revised forecast from the U.S. Department of Agriculture calling for bigger harvests and higher global stockpiles than previously expected. These and other soft commodities, as the market labels them, have been on a tear for months, fuelled by soaring consumption, a raft of weather-related woes and no small amount of investor demand.
Now, the fear is that Japan, the world's largest importer of U.S. corn, the No. 2 buyer of wheat and rice and third-biggest soybean importer, will have to curtail shipments because of damage to key ports, at a time when global supplies are rising. It seems an unlikely scenario, but serves as a useful reminder of how jittery and volatile this market can be.
Commodities, both hard and soft, have been a risk play of choice for a lot of money managers since the global meltdown of 2008 shredded stock portfolios, turned the financial sector to mush and left a giant crater where U.S. real estate holdings used to stand. Commodity-based funds are still growing at an impressive clip, taking in more than $2-billion (U.S.) net globally so far this month alone. And increasingly, as oil and metals have rocketed to levels some analysts regard as unsustainable, the focus has shifted from these hard commodities to the soft stuff - grains, cotton, sugar , cocoa and the like.
Has this food and cotton craze finally reached a peak too far? The question draws a chuckle from Ron Lawson, co-founder of Logic Advisors, who has spent almost three decades analyzing the complex world of cotton and other agricultural commodities for institutional and other clients.
The investing theme hasn't changed, he says from his sunny perch in Sonoma, in the heart of Northern California wine country. Back in pre-meltdown 2007, "we were in the process of chewing through more food than we were producing globally." Then the financial crisis hit, and food fell out of the spotlight.
But the global crisis didn't stall the dietary changes and growing food demands in markets like China. Nor did it stop the U.S. from pursuing its loony, corn-devouring ethanol policy with heavy subsidies.
Ethanol production eats up 30 to 40 per cent of the corn grown in the United States. Right now, farmers are planting a lot of wheat to take advantage of high prices, following shortages. That makes no dent in corn, though. Planting has merely shifted south, displacing other crops like soybeans, which in turn have replaced cotton in a large swath of the U.S. farm belt.
So the conditions for a long, though volatile, run in grain and cotton prices remain solidly in place. Then, of course, we have the hedge funds and other speculators who have shoved hundreds of millions into agricultural futures and swaps, part of it openly in the markets and vastly more of it through opaque over-the-counter transactions.
Anyone who denies speculation has played an important role in the dramatic price hikes simply looks clueless. Mr. Lawson laughs every time he sees a TV talking head drone on about supply and demand driving prices. They may have put the vehicle on the road, but speculators are definitely doing a lot of the steering.
"Supply and demand establishes the balance sheet. But when participants come in with amounts of money that are multiples of the available commodity, that's speculation. We always say that the specs got more money than the trade has cotton."
In the wake of the U.S. real estate collapse, declining returns in the bond market, worries about a global slowdown and fears that after a nice run, equities have nowhere to go but down, big hedge funds and other sophisticated market pros have been loading up on cotton, corn, soybean oil and other soft commodities.
"If you're a big money manager, your round lot, your loaf of bread, is $100-million," says Mr. Lawson. "Well, with $100-million, you can buy the entire open interest of a commodity contract. So when these guys come into the market, they're not doing it on a demand-supply basis. They're looking for somewhere to place money. They're looking for an investment that gives them alpha, some kind of yield that can improve their returns. They're the whale that jumps into the pond."
As for ordinary investors, they're best off treating commodities like other more exotic parts of the market, which means steering clear of them or sticking to exchange-traded funds.
"I've only been doing this 30 years. There are guys who have been around longer," Mr. Lawson says. "But one of the things I learned a long time ago is that speculating in futures is God's way of telling you you've got too much money."