December 07, 2023

Commodity Insight: This trend can be your friend

One of the oldest sayings on Wall Street touted by seasoned investors and traders goes like this: The trend is your friend.

However, the trend is only your friend until it isn’t. Or, as some say, until the trend bends and a new trend emerges.

And the big problem with following a trend is there is no certain time when you fully realize the trend has changed. Only with the benefit of hindsight and glancing at the money in your investment account can you say with certainty a trend changed.

For instance, I have been bullish on the ag commodity markets since September 2020. And for the past two years, most ag markets have rallied sharply — so sharply in fact that inflation is now running at its hottest, its highest level in 40 years.

Prior to September 2020, inflation in the United States and most other industrialized nations was running less than 2%. Now, inflationary pressures across the globe are stuck at 8% to 10% and, in some cases, higher yet.

As global inflationary trends moved upward, the world’s central banks began raising interest rates to keep prices from getting further out of hand. The major central banks, at the same time, are hiking interest rates at the fastest clip in 40 years.

As a result, a great fear blanketing the entire Big Four — stocks, bonds, currencies and commodities — is the central banks will overdo the rate hikes and spawn a global recession.

One well-known international U.S. bank posted a study not long ago that was rather eye-opening. The bank argues that when inflation in an industrialized economy rises over 5% and the central bank begins to lift interest rates it takes about 10 years for inflation to fall back under 5%.

Thus, in an industrialized economy it is likely that higher interest rates will hang around for years because killing the inflation dragon is not such an easy chore once inflation exceeds 5%.

In the week ahead, the U.S. Fed is expected to hike rates another three-quarters of a point and in early December at least another half of a point. Thus, the Fed will keep pushing rates north, which in turn will keep the trend of rising rates well in place going into 2023.

And if the trend is your friend, that means demand for a host of markets will continue to weaken. Higher interest rates push prices and inflation to lower levels over time — that is why the Fed does it!

One group of markets to suffer under higher interest rates and slowing demand is U.S. grains. Adding to the bearish outlook for U.S. grain prices with a new trend at hand are bumper crops coming from South America that are cheaper than our own, and a strong dollar that is hugging a 20-year high.

The U.S. grain markets will struggle to mount and sustain any sort of rally with a decidedly new and bearish trend locking into place.

However, there are growing concerns and subtle signs the Fed may soon slow the pace of its interest rate increases. Such a move would offer some hope to investors and ease pressure off stocks and commodities.

Still, most believe the Fed will hike rates three-quarters of a point in November and half of a point in December. But rumors are thick that the Fed may slow the rate of further rate hikes in early 2023.

If such a new policy comes to be, an argument can be made that another new trend may unfold from what has been going on since mid-June.

But allow me to make myself crystal clear about the Fed hiking rates at a record pace since June of this year: When the Fed hikes rates, I turn ice-cold bearish on virtually all markets.

The Fed hikes rates to fight inflation and based on history it tends to get what it wants. The markets most susceptible to succumbing to higher interest rates are commodities, per se.

That means hard assets such as grains, metals, petroleum and a host of other commodity markets, as well, will struggle to mount and sustain strength.

The only commodity markets that stand a snowball’s chance of avoiding much lower prices are livestock, cattle and hogs. Both markets have already endured lower values and now supplies are historically tight in terms of animals available for slaughter.

Does that mean livestock prices cannot decline in value from here? It does not. All markets may head lower if the world’s central banks make a mistake and push rates too high.

But understand that my work remains quite bullish livestock and supplies of beef and pork may show shortage in the year ahead.

The commodity supercycle I have touted since September 2020 remains in play. It has years to run.

And the volatility with commodities, per se, moving forward will be one for the record books. Exciting times are ahead.

Times are exciting, even with a new trend at hand. But even this trend can be your friend.