Why Softs Have Fallen on Hard Times
Where the platinum market has posted a strong rally recently while its forward curve remains in contango, some Softs markets are falling despite forward curves in backwardation.
We need to keep in mind the Softs sector is made up of weather derivative markets, and technical analysis takes into account changes in weather, among other things.
Technically, coffee has moved into a long-term downtrend indicating the weather in Brazil and Vietnam has improved over recent months.
In my recent conversation with Myra Saefong from MarketWatch, I mentioned how platinum’s (PLV25) forward curve was showing a standard contango (carry for those of you not from New York) indicating a far less bullish supply and demand situation than the various markets of the Softs sector we have talked about the last few years. As June came to an end, some Softs forward curves still in backwardation (inverse) could be seen in cocoa and coffee. Despite this continued bullish read on real fundamentals, both markets have struggled to find continued buying interest. To expand the overall discussion of the commodity complex in general, we see a similar situation in the Energies sector. But that’s a subject for another day. For now, let’s focus on why markets in the Softs sector have fallen on hard times, from a technical point of view.
Before we dive in, keep in mind the definition of technical analysis is “the study of market action, primarily through the use of charts, for the purpose of forecasting futures price trends”[i]. Additionally, the three key premises on which the technical approach is based are[ii]:
- Market action discounts everything. Anything that can possibly affect the market price of a commodity futures contract – fundamental, political, psychological, or otherwise – is actually reflected in the price of that commodity.
- Prices move in trends, and trends equal price direction over time. There is a corollary to this premise, “a trend in motion is more likely to continue than to reverse”. (An adaptation of Newton’s first law of motion.)
- History repeats itself.
As I talked about with US stock indexes Tuesday, each month I put together long-term analysis for a variety of markets. In the case of the Softs sector, I look at Cash Indexes found on Barchart’s cmdtyView system to avoid the roll from contract to contract and lightly traded contracts that show up on continuous monthly charts. With that in mind, here’s what the technical picture was for the sector as June came to an end.
Cotton: The Index (CTY00) looks to have moved into a major (long-term) uptrend as it took out the April high of 67.42 during June. The Index closed last month at 66.43, also a new 4-month high monthly close.
Coffee: The Index (KCY00) confirmed a new major downtrend as it fell to a new 4-month low during June. The risk is the market remains fundamentally bullish, as indicated by the continued backwardation in the futures forward curve.
Cocoa: I’m not seeing a clear trend on the monthly chart for the Index (CCY00). Meanwhile, the futures market’s forward curve remains in strong backwardation indicating a long-term bullish supply and demand situation.
Sugar: The Index (SBY00) extended its major downtrend to a low of 15.60 before closing at 16.19, down 0.91 for the month.
Orange Juice: The monthly chart looks like something we’d see with natural gas (aka the Widow Maker). That being said, the Index (OJY00) did complete a bullish key reversal at the end of April, coinciding with a bullish crossover by monthly stochastics. This means the index both signaled (stochastics) and confirmed (key reversal pattern) a new major uptrend. The market consolidated during May before breaking down again during June.
What has been the catalyst for changes in long-term trends over the past few months? Given the sector is made up of weather derivatives, for the most part, we can point to improved weather over key growing areas around the world for the various markets. While trends reflect this, we haven’t seen it change some of the forward curves, at least not yet.
[i] From Technical Analysis of the Futures Markets by John J. Murphy, 1986 edition, page 1.
[ii] Pages 2 and 3
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.