Mid-May correction raises questions

By Mike Zuzolo, Global Commodities Analytics & Consulting, LLC

The next 30 days could be crucial in determining whether the recent correction in agricultural commodities is ultimately seen as the market top for the year.

Even though the oil and wheat-led supply shocks have worsened, mid-May brought a substantial correction across many commodities, at least until the U.S.-China Summit in Beijing. This series of events makes the mid-May lows especially important as we head into summer.

If U.S. weather improves and investment funds begin anticipating higher interest rates, will they continue holding large net-long positions after northern hemisphere planting wraps up? With USDA confirming tightening wheat supplies both domestically and globally, and with the Strait of Hormuz still effectively closed as we move into the second half of May, both wheat and crude still require more demand rationing — not less — in my view.

However, as we enter the final leg of northern hemisphere row-crop planting, is that enough to keep agricultural commodities, and the broader commodity sector, in an uptrend? Unfortunately, I see the market boiling down to that single question.

Even gold has fallen roughly 14% to 15% by some metrics since the U.S.-Iran conflict began. That helps show how powerful outside pressures, including higher bond yields, may already be in reducing investor appetite for long positions.

Higher energy prices driving inflation fears

What is causing those fears and higher bond yields? In my view, it comes back to the same issue driving demand rationing from the closure of the Strait of Hormuz: higher energy prices.

We are beginning to see growing concerns in the bond market that the Federal Reserve could tighten monetary policy and raise interest rates because of inflation tied to higher energy prices. That creates a dual-edged impact on commodity investors.

This strongly suggests to me that we’re reaching levels in bond yields that could pull the U.S. dollar higher, which could start to offset price increases and therefore negate the supply shortfalls in energy, our major driver of WTI crude. The same could potentially be seen in wheat, especially if Europe and the Black Sea have ample supplies to offset our drought-stricken crop here in the United States.

Concerns extend beyond grain markets

It is also important to note that higher bond yields could negatively impact cattle and hog futures if Wall Street experiences a sharp decline. That is something I am becoming increasingly concerned about as we approach Q3.

All of this helps explain the mid-May correction across the commodity sector, including gold. Inflation-related buying earlier in the year is now colliding with fears of a Fed policy approach that was known in the early 1980s as an “inflation killer.”

Biofuel demand remains supportive

U.S. domestic biofuel demand continues to provide support, while export demand remains the key question if the U.S. dollar continues rallying alongside crude oil and Treasury yields.

In my view, futures markets have already priced in much of the premium tied to increased biofuel demand. However, I do not believe year-round E15 is fully priced in yet because of uncertainty surrounding its passage in the Senate.

The market also appears to have caught up with tightening domestic wheat supplies following the latest WASDE report, which confirmed lower-than-normal harvested acres and a significant reduction in yield potential. That is one reason HRW wheat reached its highest price in nearly two years during mid-May.

What is not clear, however, is whether the U.S. dollar will be drawn to appreciate if both Treasury yields and WTI crude continue to march higher together in the short term. If the USD does move higher, I see this as a brake on higher highs heading into summertime.

Does that mean weekly chart support levels shouldn’t hold? No, I don’t think we’ve rationed global demand enough in either crude or wheat yet. The analysis is on hold until we know more about the U.S.-China Summit and the E15 passage in Congress. If correct, prices could develop into a widening channel until the June acreage update, in my view.

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Disclaimer: There is a significant risk of loss in trading futures and options on futures, and it may not be suitable for all investors. Investors should consider the risks involved and evaluate their suitability based on their financial conditions. Past performance is not indicative of future results.

Mike Zuzolo has been a licensed Series 3 broker and analyst in commodities since 1995 and is the founder of Global Commodity Analytics and Consulting LLC. A native of Preble County, OH, Mike and his family have lived in NE Kansas since 2013. You can sign up for a free trial of his analysis at www.globalcommresearch.com.