Momentum Trading In Agricultural CommoditiesMomentum trading, a strategy as old as the markets themselves, has found fertile ground in the sprawling fields of agricultural commodities.
As the seasons change, so do the prices of wheat, corn, soybeans, and other staples, tracing patterns as predictable as the migration of birds or the spring blossom.
This paper delves into these seasonal trends, uncovering how they can serve as reliable signals for astute investors looking to harness the power of momentum trading.
SEASONAL TRENDS IN AGRICULTURAL COMMODITIES
Mint Finance has previously highlighted some of these seasonal trends in Corn and Soybean in detail previously
In short, seasonal cycles in crop performance are linked to crop harvest cycles. Pre-harvest, inventory drawdowns tend to drive price higher while post-harvest, a glut of inventory tends to drive prices lower.
Corn
Corn prices start declining in June following the harvest in China (second largest corn producer) and Brazil (third largest corn producer). Prices reach their lowest in October, coinciding with the harvest in the US.
Over the past five years, corn prices have increased in the first half of the year before declining sharply in late June. In 2024, indexed price performance shows prices sharply lagging the seasonal trend as we approach the date on which prices generally declined the last five years.
Wheat
Wheat seasonality is less pronounced than other agri-commodities due to its relatively global distribution. Still, wheat prices generally rise during the first part of the year before declining in late June as all the major producers - China, Indian, EU, Russia, and US harvest crops during this period.
This year, wheat prices started the year off on a bearish note. After bottoming in early-March, prices started to rise sharply peaking in late-May. Mint Finance covered some of the factors behind this rally in a previous paper (Extreme Weather Sends Wheat Prices Surging). Prices have started to normalize in June, a few weeks before the seasonal price decline generally begins.
Soybean
Soybean prices generally rise during the first part of the year. In late-June, as the Brazil harvest reaches its peak, prices decline sharply. Prices remain subdued until September when the US crop is harvested.
This year, prices have sharply lagged their seasonal performance. Despite the rally in early-May driven by flooding in Brazil, prices remain lower than their level at the start of 2024. Moreover, the rally following the flood-driven rally has retraced a few weeks before the seasonal price decline generally takes place.
MOMENTUM TRADING IN AGRICULUTAL COMMODITIES
Investors can execute momentum trading strategies by leveraging these seasonal trends. In this context, momentum trading strategy refers to a relatively simple trading strategy where investors either buy or sell a futures contract at the start of the month based on the seasonal price performance during that month.
For instance, if seasonal trends show that June generally results in a price decline, the strategy would consist of going short on the commodity at the start of June and closing the position at the end of the month.
Although, at face value, this strategy may seem overly simplistic, its return and accuracy are surprisingly high.
The simulations are based on a position in the front-month futures, consisting of one contract of the agricultural commodity, opened at the beginning of the month and closed at the end.
Corn
For Corn, running the momentum trading strategy would have yielded average annual returns of USD 8,500 per year over the past five years (2019-2023). Crucially, performance of this strategy in 2024 is sharply lower as it would yield total PnL of just USD 63 this year.
Wheat
Similarly, for wheat, this strategy returned an average PnL of 4,650 per year during 2019-2023. So far in 2024, this strategy would have yielded USD 6,600 in wheat futures in 2024.
Soybean
In Soybean futures, momentum trading would have been the most successful over the past five years. This strategy would have yielded an average of USD 13,600 per year between 2019 and 2023. However, in 2024, this strategy would not have been successful as it would have resulted in a loss of USD 8,700 so far.
SUMMARY AND 2024 PERFORMANCE
It is clear that although this strategy is successful on a long timeframe, it is not necessarily profitable each month. For instance, the Soybean momentum trading strategy would have resulted in a loss in 2024 while Corn momentum trading strategy would have resulted in flat returns.
The reason behind this divergence from seasonal trend is clear when comparing the seasonal price performance charts at the start of the paper. Fundamental factors can result in broad-based trends throughout the year which can skew returns. For instance, as Soybean prices have been declining for most of 2024, a long position would have resulted in a loss regardless of seasonal trends.
As such, it is crucial to supplement this strategy using fundamental inputs on what the long-term price trend for the crop is. For a crop which is in a down-cycle, a long position would not make sense and vice versa.
In the near-term, all three crop’s prices tend to decline during July based on seasonal trends. However, the outlook for corn is most bearish. The latest WASDE report , suggested that USDA expects global corn production in marketing year 2024-2025 to reach 1,220.5 million metric tons compared to a forecast of 1,219.93 million MT last month. The increase in production comes from forecast for higher output from Ukraine and Zambia more than offsetting the decline in Russia.
Moreover, USDA forecasts a season average price of USD 4.4 per bushel which is lower than the current futures price of USD 4.57. Asset managers are also shifting their view on corn prices bearish once again as COT report showed asset managers increasing net short positioning last week.
Both fundamental and seasonal factors support a price decline in corn over the next month. However, seasonal trends are not exact. Particularly in 2024, seasonal trends have underperformed their usual returns from the last five years.
Investors can opt to use options instead of futures to express the same view of weakening prices. Options provide fixed downside risk and require only an upfront premium, avoiding the need to manage margins as futures prices fluctuate.
A long put position in CME corn options expiring on August 23 (ZCU24) can be used to gain downside exposure.
CME Corn puts are relatively cheaper compared to calls. Moreover, options IV (measured by the CVOL index) is lower compared to the peaks seen during the same time last year. An options position would benefit from both falling prices and rising IV.
Source: CVOL
A long put options position on corn futures presents fixed downside of USD 464 (USc 9.29 x 5000/100) and unlimited upside. A strike price of USc 430/bushel represents delta of -0.29. This position would break-even at USc 420/bushel.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Agricommodity
Extreme Weather Sends Wheat Prices SurgingWheat plays a critical role in global agriculture and trade. Extreme weather has turned wheat prices bullish, rising more than 22% in a month after having languished for more than two years.
After reaching their lowest level in more than three years in March 2024, prices have rebounded strongly. Wheat rally is driven by extreme weather events in multiple places compounded by supply-demand imbalances.
Wheat rally is far from over. The May 2024 WASDE report painted a surprisingly positive outlook for wheat, suggesting an increase in US production. Outlook may be too optimistic, making revisions likely. Prices face risk to the upside once weather impact is comprehensively reassessed.
This paper posits a long position in wheat options benefiting not only from price appreciation and from expanding volatility.
WASDE PAINTS A POSITIVE WHEAT OUTLOOK
Recent WASDE report provides initial forecasts for 2024/25 marketing year (MY24/25) and updates projections for the current MY. These updates are crucial for estimating ending stocks which will be carried over to the next year.
Global production is expected to grow 1.3% in the upcoming MY to 798.19MT. Projections are even more optimistic for the US crop. USDA expects US wheat production in MY24/25 to be 3% higher YoY and total supplies to be almost 6% higher YoY.
Source: USDA
WHEAT CROPS ARE GETTING IMPACTED BY SEVERE WEATHER
Russia is the largest wheat exporter commanding 24% of total global exports. Russia has been hit by severe frost and cold.
Three of Russia’s key grain producing regions have declared a state of emergency, stating that May frost has caused severe damage to crops, reports Reuters . This year’s crop output will be lower. Frost linked damage follows record hot April which also harmed wheat crops.
The USDA has reduced its outlook for Russian wheat production by 3.5MT which might be an underestimate given widespread damage. WASDE report was released merely two days after Russia declared emergency, leaving USDA with little to no time to assess the impact.
STOCKS-TO-USE NEAR ALL-TIME-LOW
Data Source: PSD
Stocks to Use levels at major wheat exporters is currently at a 16-year low at 13.8%. It is expected to drop further to a record low of 12.4% in the upcoming MY24/25.
Low stocks-to-use ratio suggests that supplies are tight. Ending stocks are low relative to total consumption. Low stock-to-use ratios make prices extremely sensitive to minor shocks in physical markets.
MANAGED MONEY HAVE REVERSED COURSE ON WHEAT BEARISHNESS
Sentiment is shifting rapidly. Asset managers have been net short on wheat futures since 2022. This trend has reversed sharply over the last month with asset managers cutting short positioning by 70%. Net short positioning is at its lowest level since October 2022. Last week, asset managers continued to reduce their short positioning (down 35% over the past month) while also increasing their long positioning.
Source: CME QuikStrike
Bullish sentiment prevails with a put/call ratio of 0.57 in wheat options. Calls dominate both near-term and later contracts. Recent options market trading has been bullish for later expires.
Despite strong rally, implied volatility is lower than the levels seen last year and even during late 2022 signalling potential IV expansion.
Source: CME CVOL
HYPOTHETICAL TRADE SETUP
Wheat faces multifaceted upside risks stemming from weather-driven uncertainty and damage which may not have been factored into USDA’s supply outlook. Wheat supply also faces the risk of disruption from record low stocks-to-use ratio.
Wheat prices are up 22% over the last one month. A long futures position may be impacted negatively by a near-term correction. Instead, a long call position offers limited downside and substantial upside from expanding volatility and rising prices.
TradingView recently launched options suite brings traders a raft of options analytical tools. Wheat options chain can be visualised clearly.
Options IV across a range of expiries to identify key strike levels can also be visualised.
Strategy simulator enables evaluation of various strategies intuitively by visualizing the payoff based on not only price but also expansion or contraction of IV or time-decay.
The above hypothetical trade setup shows the payoff for a simple long call position in OZWU24 contract expiring on 23/August at a strike price of 750.
The premium for this option as of 17/May stood at 33 cents/bushel which results in a premium of USD 1,650 for a full options contract consisting of 5,000 bushels.
The above position breaks even at USc 783. If IV expands by 2%, the position would break even at USc 778.
Assuming constant IV, the:
• trade delivers profit of 1,850, if prices rise to 820.
• option expires worthless leading to a loss of 1,650 if prices remain below strike.
The options simulator features simple and intuitive interface enabling visualization of common options strategies. The tool also enables users to easily create and customize trading strategies.
Alternative to a long call, the bull call spread provides a pre-determined maximum profit and loss. The long call benefits from price rise and volatility expansion.
While short call offsets long call premium reducing potential losses. However, the profit potential is limited because any appreciation beyond the short call strike is negated by equivalent losses from the short position.
Bull Call Spread consists of a long call at a strike of USc 680 and a short call at a higher strike of USc 700. The width of the spread is set at 2 (700-680), a wider range can offer higher upside and reward/risk ratio, but it is only viable when the expected move is large.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Corn Prices To Fire Up on Rising Energy CostsIt is official. Inflation is back. But not everywhere. Food inflation is on the decline. All three major crops, Soybean, Wheat, and Corn have declined substantially. Bearish sentiments rings loud across agri with ample supplies combined with solid harvest expectations.
Among crops, corn has fared best. Its prices have not declined as much. Corn outlook is positive given South American supply uncertainty and gasoline linked demand spike.
Corn prices face downside risk from ample supply in the near term. Prices have the potential to spike during later part of the year due to supply uncertainty and higher consumption.
Traders can deploy a calendar spread in CME Corn futures comprising of a short September 2024 Corn Futures (ZSU2024) and a long March 2025 Corn Futures (ZSH2025) to gain from shifting dynamics.
RECORD US CROP WILL SUPPRESS NEAR TERM CORN PRICE
The US produced a record 389.69 million MT of corn last year as per latest USDA figures. Massive production is a result of record high yield of 177.3 bushels per acre.
Globally, corn production in the current marketing year is expected to reach a record 1,227 million MT, due to the US crop last year.
Higher supply is expected to lead to a buildup in ending stocks. Stocks are expected to increase from 302.19 million MT to 318.28 million MT. This represents a buildup of almost 16 million MT.
Ample supplies are a headwind to near term corn prices.
USDA ESTIMATES MAY BE TOO OPTIMISTIC
Global corn production forecasts by USDA may be too optimistic. Upcoming harvests from Brazil and Argentina may spring surprises to the downside.
USDA’s forecast for the Brazil corn crop is currently at 124 million MT. Brazil’s national agricultural agency - CONAB - puts the harvest at 110.9 million MT as per their latest crop survey . The difference stems from USDA’s assumption of higher planted area.
CONAB recently cut its estimate for planted area pointing to lower crop prices dissuading farmers from planting corn. Planting in Brazil is delayed from its usual schedule.
USDA is also optimistic about the Argentinian crop. It reduced its forecast for Argentinian corn by 1 million MT to 55 million MT in the latest WASDE report. However, that is still optimistic given the ongoing spread of spiroplasma disease. Last week, Argentina’s Rosario Exchange slashed corn estimates to just 50.5 million MT from a previous forecast of 57 million MT citing crop loss linked with diseases.
USDA estimates are 18 million MT higher than harvest forecasted by regional agencies across Brazil & Argentina. Corn supplies may end up being much tighter than the USDA is currently forecasting if harvests come softer than anticipated.
ETHANOL PRODUCTION IS LIKELY TO INCREASE CORN CONSUMPTION
USDA increased its forecast for corn consumption for ethanol production by twenty-five million bushels (635k MT) in the latest WASDE report. With gasoline and crude prices on a tear, ethanol blending into gasoline is likely to remain elevated during the coming months driving corn demand.
Sustainable Aviation Fuel (SAF) serves as another source of corn demand in 2024. The Biden Administration is set to release its primary climate model for SAF subsidies under the Inflation Reduction Act in the “very near future”.
While recent reports have stated that the model may be restrictive compared to corn-ethanol industry expectations, the subsidies will undoubtedly drive higher demand for corn-ethanol.
CORN FUTURES CONTANGO IS STEEPENING
Corn Futures term structure has become noticeably steeper over the past three months. Premium for dated contracts have increased. Specifically, corn delivery in later part of 2024 and early 2025 command higher premium.
MARKET METRICS ARE TURNING LESS BEARISH FOR CORN
CME Corn Options positions are currently skewed bullish with a put/call ratio of 0.84. Over the past week, bullish positioning has increased with large call option buildup on June (OZCN4) and December contracts (OZCZ4).
Asset managers have also started to reduce net short positioning on CME Corn Futures since positioning reached its all-time low mid-February.
HYPOTHETICAL TRADE SETUP
South America corn supply remains uncertain even as the US delivers a record harvest. Corn prices will remain bearish in the near term amid ample supplies. Longer term, supply shocks and rising demand has the potential to send corn prices higher. This is evident from steepening contango in CME Corn Futures.
To express the view on corn prices increasing towards the end of the year, traders can establish a calendar spread comprising of short position in September 2024 futures (ZCU2024) and a long position in March 2025 futures (ZCH2025). CME corn futures offer deep liquidity even for contracts in 2025 allowing such calendar spreads to be executed efficiently.
A hypothetical trade setup comprising of the calendar spread consisting of short ZCU2024 and long ZCH2025 also offers margin benefits. The calendar spread position is margin efficient with the entire position requiring margin of just USD 350 as of 15/April/2024.
This position not only benefits from the supply trend but also the seasonal trend in corn prices. Corn prices tend to rise from October through February due to seasonal factors. Between April to September, prices tend to decline. This hypothetical spread is supported by both trends.
• Entry: 1.06185 (ZCH2025/ZCU2024 = 485/456.75 as of 12/April)
• Target: 1.076
• Stop Loss: 1.052
• Profit at Target: USD 323 (Target price = 1.33% higher than Entry => Profit = 1.33% x notional = 1.33% x (485 x Contract Size) = 1.33% x (485 x 5000/100))
• Loss at Stop Loss: USD 225 (Stop level = 0.93% below entry => Loss = 0.93% x notional)
• Reward to Risk: 1.44x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Solid Brazilian Rains Dampen Soybean PricesSoybean prices have been on a rollercoaster fuelled by turbulence over the last month amid elevated weather concerns, changing production yields, and geopolitical upheavals affecting prices. Winters are vital for bean traders. This paper delves into the various forces at play to guide traders and portfolio managers to navigate through the rough weather.
Favourable weather combined tail winds for Soybean harvests plus weakness in destination markets are setting the ground for bearishness in bean prices. A short position in CME Soybean futures can be used to manage risk.
US SOYBEAN HARVEST RESULTS
Soybean harvest in the US has concluded providing a more certain supply outlook for the ongoing marketing year. Next Soybean harvest will take place in March-June in South America. Until then, current inventories will have to meet the demand.
As per USDA update , Soy harvesting in the US is 90% complete. Yields for the 2023/2024 marketing year were updated to 49.9 bushels/acre in the November WASDE report compared to 49.6 bushels/acre in the October report.
This resulted in an upward revision to the production and ending stocks figures as well since the consumption forecast remained unchanged. A similar update was reported by USDA in the global soybean outlook which suggested that global soybean production would be marginally higher.
Despite the upward revisions, the US production figures represent a YoY decline of 4 million MT (-3.3%). The upward revision then, provides a larger buffer to account for potentially higher consumption.
This is vital because bean inventory balances in the US this year are tighter than the previous two years. US Ending stocks are forecast to be 6.68 million MT compared to 7.3 million MT last year.
As a result, although the upward revision expanded the buffer, it is quite narrow which could exacerbate a shortage in case consumption edges higher.
SEASONAL TRENDS
As highlighted by Mint in a previous paper , seasonal trends in Soybean futures are affected by harvest. During harvest, prices decline before recovering post-harvest as inventories are depleted. However, the seasonal trend is distinct during El Niño years where returns underperform the usual average, especially in December-January.
BRAZIL WEATHER CONCERNS LIFTED
Soybean markets are heavily influenced by weather in Brazil. Hotter than expected weather and erratic precipitation raised concerns for Brazilian crops which drove Soybean prices higher over the past month.
Brazil experienced a strong heat wave last month which has a negative effect on crops. Weather effects on crop yields are most pronounced during the early stages of growth.
However, weather is now set to improve as weather forecasts suggest the arrival of rains and milder temperatures ahead. Both are positive for the bean crop.
Still, higher-than-expected precipitation remains a concern for the crop. As highlighted by University of Delaware , too much rainfall during the planting stage can lead to significant yield reduction.
Source: USDA
Brazil is the largest producer of Soybean and its harvest had been expanding rapidly over the past three years. This had previously led to oversupply concerns in global markets, exacerbated by a low demand environment in the largest soybean consumer China.
Though consumption in China is forecast to increase YoY, it will not be enough to match the increase in global production (especially in Brazil) per the latest WASDE estimates . Net effect is larger ending stocks globally which is bearish for Soybean prices.
EL NIÑO UPDATE
In this El Niño year, unexpected weather pose significant concerns as it deviates from the anticipated impact on soybean crops outlined in our previous paper . While El Niño typically brings favourable conditions, such as increased rainfall and mild weather leading to a 3.5% higher soybean yield on average.
Brazil is experiencing unexpectedly warm weather and low precipitation, diverging from the usual patterns. The unpredictability of these conditions amplifies their potential impact on prices compared to previously expected El Niño effects.
Source - NOAA
El Niño continues to evolve adversely as Oceanic Niño Index (ONI) has reached its highest level since 2016. Sea Surface Temperatures (SST) at Niño 3.4 is another indicator that has reached an all-time-high.
Source - NOAA
SIGNAL FROM SOYBEAN FUTURES MARKET
Technical signals suggest a bearish trend in bean futures. Front month bean contract was on an upward trend since mid-October. The front month contract tested but failed to pass a key pivot resistance level of 1,381 USc/bushel. Price has since declined 5% and points to a reversal as the Moving Averages close to forming a bearish crossover.
Asset managers switched from net short to net long positioning over the past month. However, over the last 2 weeks, asset managers have reduced net long positioning by 20k contracts.
Options markets point to bearishness as participants are positioned for Soybean price to decline with a P/C ratio of 1.31 which suggests more bearish bets than bullish ones.
Further, bearish bets have increased sharply over the past week with the largest increase in puts on the April monthly contract and December monthly contract. Moreover, participants have reduced call OI on the front-month December contract.
HYPOTHETICAL TRADE SETUP
With the overhang of negative weather in Brazil lifted, bean prices are likely to decline and pare gains from the past month due to a weak demand environment. Market metrics also suggest a bearish trend. To gain exposure, investors can deploy a short position on Soybean futures expiring in Feb ( ZSH2024 ).
CME Soybean futures expiring in March require a maintenance margin of USD 2,800 (as of December 4th) and provide exposure to 5000 bushels.
Entry: USc 1,336
Target: USc 1,272.25
Stop Loss: USc 1,381
Profit at Target: USD 3,187
Loss at Stop: USD 2,250
Reward/Risk: 1.42x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.