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Commodity markets simmering down

It looks like a much calmer ride could be in store for markets this year

Figure 1.

There’s no denying 2020 was an unprecedented year. What surprises are in store for us this year?

After so much uncertainty last year triggered by COVID, it’s easy to think that the surprises will continue into 2021. But, maybe the biggest surprise of all will be that there will be no big surprises this year!

To help understand what market surprises, if any, might be in store for us this year, it’s good to look at price change as well as price itself. We want to analyze not just the price itself, but what the price is doing and how it’s behaving. The change in price, or volatility, can offer a lot of insight into market activity and what price patterns or trends could develop.

To start, it’s good to realize that market returns, asset prices and volatility are often mean reverting. That’s just a fancy way of saying that usually what goes up, must come down and go back to the mean or the average. Most of the time, things go back to normal; the biggest variable is just how long that takes. In a low-volatility environment, a quiet market trend could continue or it could be the calm before the storm. At the same time, a high-volatility environment with lots of frenetic trading activity and wild price swings usually doesn’t last too long.

Comparing current market conditions to the past gives you a sense of how prices have been acting compared to normal. And more importantly, offers insights into how things could behave going forward.

Major financial and economic markets like stocks, interest rates, oil and gold (see Fig. 1 at top) have already had their big volatility moves both up and then down with levels now settling back in to a more normal range.

The rapid development and deployment of COVID-19 vaccinations, indications of mass inoculation before year-end, massive government fiscal as well as monetary stimulus, greater U.S. political stability, and record-low real interest rates, are all positive for the global economic recovery and equities in 2021.

Of course, there will be ups and downs, driven by how quickly these worldwide vaccination programs take effect in addition to the usual political factors and corporate earnings.

Figure 2.

Some of the key markets that affect farmers across the Prairies like cattle, interest rates and the Canadian dollar (see Fig. 2 above) have already seen a surge in volatility and then subsequent reversion back to normal. Once again, what the price activity of the past year has taught us is that eventually things do calm down.

Turning to the crop markets, like wheat, canola, and soybeans (see Fig. 3 below), volatility levels are still going higher. Big price moves often beget big price moves as we’ve seen in corn and soybeans over the past several months with prices reaching multiple year highs.

Figure 3.

Keep in mind that there’s still a lot of growing season weather concerns from around the world in front of us. This will bring its own special brand of volatility and potential price surges. While trees don’t grow to the sky, it doesn’t mean prices won’t stay at these elevated levels for weeks to come.

The important point is you don’t want to get complacent. Be prepared to hedge some of your production at these great new crop prices. Incremental pricing and options-based strategies are ideal to protect the downside but still give you upside potential if markets keep rising. Options also allow you to better manage production and delivery risk this early in the crop year.

Bottom line, a return to some normalcy could be the case for financial markets like stocks, bonds and currencies. However, one area that is certainly still experiencing a lot of volatility is the grain market, and this could continue well into 2021. Eventually grain prices and volatility will settle down back to more normal levels. The only question is how long that takes. Until then, there will be lots of fluctuation. As always, diversified marketing strategies that include financial tools like options can help protect against excessive risk while still taking advantage of market opportunities.

About the author

Columnist

David Derwin is a commodity portfolio manager with PI Financial Corp. The views here are his own, presented for educational purposes, rather than as specific market advice. For a copy of the complete research study “Farming Big Data — Myths, Misperceptions & Opportunities in Agriculture Commodity Hedging” contact him at [email protected]

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