Agricultural Commodities Part 2: Softs, Livestock Feed, and Trading
Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010
This is Part 2 of Chapter 8 by Nicole Moran and Kelsey Syvrud. In the first part, we covered grains, oilseeds, and dairy. Now we get into the soft commodities: cocoa, coffee, sugar, and cotton. We will also look at the boom and bust in commodity index investing and where to find market information.
What Are Soft Commodities?
Soft commodities are products grown primarily in tropical climates. The main ones are cocoa, coffee, sugar, and cotton. They are called “soft” because they are grown rather than mined. Metals and oil are “hard” commodities. The Intercontinental Exchange (ICE) is particularly important for soft commodities trading, having acquired the New York Board of Trade in 2007.
Cocoa: Africa’s Cash Crop
Cocoa trees need tropical environments, so production is concentrated near the equator in Africa, Asia, and Latin America. Africa dominates, producing more than 70 percent of global supply. Cote d’Ivoire alone accounts for roughly one-third.
Here is something interesting: the U.S. does not grow cocoa at all, but it is one of the biggest processors. The Netherlands is the other major processing hub. Cocoa gets turned into chocolate, beverages, cocoa butter, and even animal feed.
The crop takes three to five years before a cocoa tree becomes productive. Each harvest yields about 20 pods per tree, which translates to roughly four pounds of cocoa. These yields are sensitive to pests, diseases, droughts, and climate changes. In Cote d’Ivoire, the main harvest runs October to March with a secondary season from May to August. Cocoa can be stored for about 12 months.
You can trade cocoa futures on both the CME and ICE. Each contract covers 10 metric tons. ICE contracts require physical delivery while CME futures are cash-settled.
Coffee: The World’s Most Traded Tropical Commodity
Coffee is the most widely traded tropical agricultural product. More than 70 countries grow it, all in equatorial regions. Over half of Americans over 18 drink coffee, averaging about 3.1 cups per day.
Global production hit about 153 million 60-kilogram bags in the 2015-2016 trade year. Brazil is the biggest producer at 32 percent of the total, followed by Vietnam at 19 percent. The U.S. grows essentially no coffee (except a tiny amount in Hawaii) but is the second largest importer behind the European Union.
Two types of beans dominate the market: arabica and robusta. Arabica beans taste better and command higher prices. Robusta has nearly twice the caffeine, is sturdier, needs less care, and yields more per plant. Vietnam leads robusta production while Brazil leads arabica.
Like cocoa, coffee plants take three to five years to mature. Both crops are vulnerable to climate changes and natural disasters that can cause price spikes. There is also a growing fair trade movement that pushes for sustainable farming and prohibits child labor.
Arabica futures trade on both CME and ICE. One contract covers 37,500 pounds. ICE contracts are physically delivered while CME futures are cash-settled. Robusta futures are only on ICE.
Sugar: Subsidies and Global Politics
Sugar is everywhere. Americans consume roughly 130 pounds of sugars and sweeteners per person per year. The top six producing countries, led by Brazil, India, the EU, Thailand, China, and the U.S., account for over 60 percent of annual supply.
Sugar comes from two sources: sugar cane (80 percent globally) and sugar beets (the primary source in the U.S., producing 55 percent of domestic sugar). Sugar cane grows in tropical climates and must reach a mill within 16 hours of being cut to prevent juice evaporation. Sugar beets are sturdier and can grow in different climates, but they lose sugar during storage.
The politics around sugar are intense. The U.S. sugar program sets minimum prices, domestic marketing allotments, and tariff-rate quotas. U.S. raw cane sugar prices have been higher than world prices since the early 1980s because of these protections. Between 2010 and 2015, U.S. raw cane sugar ranged from 28 to 56 cents per pound, while the world price ranged from 13 to 28 cents per pound.
Two important futures contracts: Sugar No. 11 (world raw cane sugar, priced from Caribbean ports) and Sugar No. 16 (U.S. raw cane sugar, priced in New York). The Sugar No. 11 contract on ICE covers 112,000 pounds and settles physically. On CME, it is cash-settled.
Cotton: From Subsidy Wars to Market Shifts
Cotton accounts for about 30 percent of total fiber use worldwide. India, China, and the United States are the top three producers, together accounting for roughly 67 percent of global production. The U.S. exports about 71 percent of its cotton output.
China is the world’s largest cotton consumer, using 43 percent of global supply in 2007. Much of that goes into manufactured goods that get exported back to the U.S. and other countries. So the U.S. grows the cotton, ships it to China, and then buys it back as clothing. Roughly 97 percent of manufactured cotton goods consumed in the U.S. came from imports in 2007.
Cotton subsidies have caused international trade disputes. In 2005, U.S. subsidies to cotton farmers hit $3.3 billion, more than five times what grain farmers received. Brazil filed a complaint with the WTO, which ruled that U.S. subsidies were illegal. This led to changes in subsidy programs.
Starting around 2006, U.S. cotton acreage dropped significantly as farmers switched to more profitable crops like corn and soybeans, driven by biofuel demand.
Cotton futures trade on both CME and ICE, with contracts covering 50,000 pounds. ICE settles physically, CME settles with cash.
The Commodity Boom and Bust
Between 2006 and 2008, agricultural commodity prices went wild. Rice prices increased 130 percent. Butter went up 110 percent. Soybean oil rose 105 percent. Corn jumped 83 percent. This was driven by a combination of biofuel demand, emerging market growth (especially China), the 2007-2008 financial crisis pushing investors toward commodities, and genuine supply tightness.
Total commodity index investments rose from $15 billion in 2003 to about $200 billion by mid-2008. At the peak, commodity index traders held 35 to 50 percent of outstanding wheat contracts on the CME. This raised concerns about whether speculative investment was distorting prices beyond what fundamentals would dictate. The U.S. Senate produced a report in 2009 expressing concern over index investment in wheat markets.
The debate over whether speculation drives commodity prices or just follows them is still ongoing. But the S&P GSCI Agriculture Index tells the story of volatility either way: annual returns ranged from negative 28.8 percent in 2008 to positive 34.2 percent in 2010, with a 10-year standard deviation of 25.4 percent.
Where to Find Market Information
The chapter wraps up with useful sources for agricultural data. The USDA is the most important, providing free production, consumption, and trade data. The World Agricultural Supply and Demand Estimates (WASDE) report is published monthly and is considered the benchmark that all other forecasts are compared against. The CME and ICE provide price, volume, and open interest data. The World Bank maintains time-series agricultural data through its World Development Indicators databank. For private data, DTN offers a subscription service with real-time weather and market information.
My Take
The soft commodities section really highlights how geographically concentrated production creates risk. When one-third of global cocoa comes from a single country, or 75 percent of coffee comes from four countries, political instability or weather events in those places can move world prices. That concentration risk is something investors need to take seriously.
The sugar section was eye-opening for how much government intervention shapes agricultural markets. When U.S. domestic sugar costs twice what world sugar costs because of policy choices, that is not a free market. It is a reminder that agricultural commodities are always political.
Previous: Agricultural Commodities Part 1: Grains, Oilseeds, and Crop Markets