Kub's Den                     05/01 04:55

   Commodities Hit a Wall -- in a Good Way?

   Inflation is both the cause and the result of higher commodity prices, but 
does that mean we are now in a new timeframe with a new long-term trading range 
that adjusts for inflation?

Elaine Kub
Contributing Analyst

   If someone says that commodity prices have "hit a wall," your reaction to 
that statement really depends on who you are and what economic role commodities 
play in your life.

   If you're a farmer, you think, "I know commodity prices seemed to hit a wall 
back in 2022, darn it; I wish commodity prices would go back higher and jump 
that wall." If you're a miner or an oil baron or any other sort of commodity 
producer, you probably share that same sentiment.

   But if, on the other hand, you're a grocery shopper, or someone buying 
gasoline at a gas station, you think, "I know commodity prices have hit a wall, 
darn it; they've been going down for the past couple of years and I wish they 
would keep going down."

   Therefore, I had a moment of cognitive dissonance when I read the World Bank 
Group's Chief Economist Indermit Gill, quoted in the Financial Times, say: "A 
key force for disinflation -- falling commodity prices -- has essentially hit a 
wall. That means interest rates could remain higher than currently expected 
this year and next."

   Personally, I don't mind when there's a "wall" preventing grain prices from 
falling any further. In fact, I would usually give it a friendlier term, like 
"floor" or "support" or "at least a slim chance of basic profitability for 
commodity producers."

   But a World Bank economist, representing as he does all the globe's 
commodity consumers in developing countries and everywhere, who must purchase 
food and fiber and fuel, and must sometimes borrow money to do so, 
understandably has a different perspective. The dwindling commodity prices of 
the past two years have been a welcome reprieve for most of the people in this 
world.

   For now, anyway, the dwindling seems to have stopped. Will it stay stopped? 
Whatever we choose to call this phenomenon -- a wall, a floor, a support level 
-- is there any reason to believe it really will prevent commodity prices from 
falling further in the long term?

   Well, those who believe in technical market analysis would of course say: 
yes. They could recite to you magic numbers or 42% retracement levels below 
which any market's chart "shouldn't" fall on any chart showing price movements 
on any time scale -- weekly, daily, or even minute-by-minute. Honest 
back-testing of their prophecies would prove them to be incorrect, but it is 
still possible to find analysts who will prophesy some price levels or "walls" 
to guide a market from going either higher or lower than a certain number.

   Let's say we don't believe technical resistance or support levels can be 
proven to work in efficient markets, where no one's magic number system can 
outperform the swift reactions of thousands of other sophisticated traders 
trading based on thousands of different points of information. Nevertheless, a 
very long-term chart of commodity prices does indeed show that these markets 
tend to find comfortable equilibrium price levels over many years, and that 
those equilibrium prices themselves have changed during distinct periods.

   This is less an exercise of predicting what price levels may act as 
guardrails to wall in a commodity market's chart, and more a recognition of 
distinct eras or regimes in commodity markets. A very long-term chart of 
monthly grain futures prices during the past 40 years would show a long stretch 
between 1984 and 2007, when corn prices tended to stay "walled" between $1.50 
and $5 per bushel. Wheat prices were "walled" between roughly $2.50 and $5 per 
bushel, and soybean prices were "walled" between roughly $4.50 and $10 per 
bushel.

   Then, in 2008, something changed, and commodities were in a new world with 
new rules and new "walls." It wasn't just the renewable energy boom driving up 
corn prices to feed ethanol plants, either, because the same shift occurred for 
energy, metal, and soft commodities at the same time. Call it a commodity 
supercycle, call it a demand-driven rally, or call it, simply, China. Whatever 
you call it, in that new regime from 2008 to 2022, the equilibrium prices -- or 
"comfort zone" -- for corn now seemed to be between $3 to $8 per bushel. For 
wheat, it seemed to be between $4.50 and $10 per bushel, and for soybeans, it 
seemed to be between $8.50 and $17 per bushel.

   Now, what the World Bank economist's "wall" statement has me wondering is 
this: In April 2024, are we still living in that same regime? Could corn prices 
dwindle all the way back down to their comfortable equilibrium price of $3 per 
bushel? Or, alternatively, after the pandemic of 2020, the supply shocks of 
2022, and the global inflation everywhere, have grains and other commodities 
stair-stepped up into a new era, with new comfort zones? Is there really some 
sort of wall that might keep corn, wheat, and soybeans at or above their 
present levels (roughly $4.30, $5.80, and $11.40, respectively)? Is there some 
broad economic force that will similarly keep U.S. crude oil above $70 per 
barrel and copper above $3.50 per pound?

   Certainly, there could be some economic theory behind the new, higher 
"floor" levels, which would be worthy of future study if those floors really do 
hold over the long term. Because the inflation of everything -- including the 
labor it takes to mine the copper or farm the grain -- has increased the 
underlying costs of producing these commodities, their long-term equilibrium 
prices may now be stair-stepped higher, and any dip below those levels might 
result in production cuts that would cause the markets to self-correct higher, 
back above the new "floors."

   Inflation is therefore both the cause and the result of these markets' 
prices. As Gill also stated, "The world is at a vulnerable moment: A major 
energy shock could undermine much of the progress in reducing inflation over 
the past two years." That would be the worst of all possible worlds for grain 
producers -- higher inflation, higher prices for inputs, but potentially 
still-low grain prices exploring the limits of which walls might guide their 
path.

   **

   Comments above are for educational purposes only and are not meant as 
specific trade recommendations. The buying and selling of grain or grain 
futures or options involve substantial risk and are not suitable for everyone.

   Elaine Kub, CFA is the author of "Mastering the Grain Markets: How Profits 
Are Really Made" and can be reached at analysis@elainekub.com or on social 
platform X @elainekub.




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