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Coffee Perks Up Agricultural Index
The commodity is hot, but traders may not want to rely too much on its current dominance.
Howard L. Simons     

Long before natural gas futures entered the scene in the early 1990s, coffee ("C"), or Arabica, futures -- traded then on the New York Board of Trade, now part of the InterContinental Exchange (NYSE:ICE) -- were the most volatile physical commodity. There are several good reasons for this. First, the supply of coffee is very inelastic: Small changes in supply can have a very large effect on price. Second, demand is elastic, as firms such as Starbucks (NASDAQ:SBUX) have shown. If you need your fix of morning joe, you're probably willing to pay up to obtain it, and a lower price probably wouldn't induce you to guzzle more. Third, while certain goods don't grow on trees, coffee actually does; a crop shortfall leading to higher prices today will induce large new production in subsequent years.
 
The Agricultural Index

While grains such as wheat and corn probably shouldn't be lumped together with soft commodities such as sugar, coffee, or cocoa, they do have the common thread of crop cycles -- sometimes in one hemisphere, sometimes in two hemispheres. The good index-meisters at Dow Jones-UBS have separate indices for grains and softs, and a combined one for agricultural commodities. The year-to-date total return on this index is 15.46%. This is what happens when you have droughts in Brazil and unnaturally cold weather in the winter wheat belt of the US.
 
If we peek behind the curtain at this gaudy return, we find it is skewed massively by coffee's 83.1% gain. Corn is a distant second at 13.2%.  This is the sort of thing that gets stock market technicians yelping about narrow market advances and the like.



We also need to step back, presuming we're not standing near a cliff's edge, and look at the history of the agricultural index's total returns, relative to those for US stocks, as measured by the Russell 3000 Index (INDEXRUSSELL:RUA), seven- to 10-year Treasuries, investment-grade bonds, and high-yield bonds. Instruments such as the PowerShares DB Agricultural Fund (NYSEARCA:DBA) did not exist in January 1991, but the comparative underperformance of the agricultural index should give you food for thought.



Let's just say this index does not scream "buy and hold" as much as it does "chuck and duck." The long-term history is one where upturns arrive swiftly and disappear swiftly, and where the roll yield between futures contracts eats you alive. The old floor traders understood coffee to be a great day-trading instrument and behaved accordingly. Why anyone would want to expose themselves long term to an index dominated by a single commodity is beyond me.
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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
Coffee Perks Up Agricultural Index
The commodity is hot, but traders may not want to rely too much on its current dominance.
Howard L. Simons     

Long before natural gas futures entered the scene in the early 1990s, coffee ("C"), or Arabica, futures -- traded then on the New York Board of Trade, now part of the InterContinental Exchange (NYSE:ICE) -- were the most volatile physical commodity. There are several good reasons for this. First, the supply of coffee is very inelastic: Small changes in supply can have a very large effect on price. Second, demand is elastic, as firms such as Starbucks (NASDAQ:SBUX) have shown. If you need your fix of morning joe, you're probably willing to pay up to obtain it, and a lower price probably wouldn't induce you to guzzle more. Third, while certain goods don't grow on trees, coffee actually does; a crop shortfall leading to higher prices today will induce large new production in subsequent years.
 
The Agricultural Index

While grains such as wheat and corn probably shouldn't be lumped together with soft commodities such as sugar, coffee, or cocoa, they do have the common thread of crop cycles -- sometimes in one hemisphere, sometimes in two hemispheres. The good index-meisters at Dow Jones-UBS have separate indices for grains and softs, and a combined one for agricultural commodities. The year-to-date total return on this index is 15.46%. This is what happens when you have droughts in Brazil and unnaturally cold weather in the winter wheat belt of the US.
 
If we peek behind the curtain at this gaudy return, we find it is skewed massively by coffee's 83.1% gain. Corn is a distant second at 13.2%.  This is the sort of thing that gets stock market technicians yelping about narrow market advances and the like.



We also need to step back, presuming we're not standing near a cliff's edge, and look at the history of the agricultural index's total returns, relative to those for US stocks, as measured by the Russell 3000 Index (INDEXRUSSELL:RUA), seven- to 10-year Treasuries, investment-grade bonds, and high-yield bonds. Instruments such as the PowerShares DB Agricultural Fund (NYSEARCA:DBA) did not exist in January 1991, but the comparative underperformance of the agricultural index should give you food for thought.



Let's just say this index does not scream "buy and hold" as much as it does "chuck and duck." The long-term history is one where upturns arrive swiftly and disappear swiftly, and where the roll yield between futures contracts eats you alive. The old floor traders understood coffee to be a great day-trading instrument and behaved accordingly. Why anyone would want to expose themselves long term to an index dominated by a single commodity is beyond me.
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
Daily Recap
Coffee Perks Up Agricultural Index
The commodity is hot, but traders may not want to rely too much on its current dominance.
Howard L. Simons     

Long before natural gas futures entered the scene in the early 1990s, coffee ("C"), or Arabica, futures -- traded then on the New York Board of Trade, now part of the InterContinental Exchange (NYSE:ICE) -- were the most volatile physical commodity. There are several good reasons for this. First, the supply of coffee is very inelastic: Small changes in supply can have a very large effect on price. Second, demand is elastic, as firms such as Starbucks (NASDAQ:SBUX) have shown. If you need your fix of morning joe, you're probably willing to pay up to obtain it, and a lower price probably wouldn't induce you to guzzle more. Third, while certain goods don't grow on trees, coffee actually does; a crop shortfall leading to higher prices today will induce large new production in subsequent years.
 
The Agricultural Index

While grains such as wheat and corn probably shouldn't be lumped together with soft commodities such as sugar, coffee, or cocoa, they do have the common thread of crop cycles -- sometimes in one hemisphere, sometimes in two hemispheres. The good index-meisters at Dow Jones-UBS have separate indices for grains and softs, and a combined one for agricultural commodities. The year-to-date total return on this index is 15.46%. This is what happens when you have droughts in Brazil and unnaturally cold weather in the winter wheat belt of the US.
 
If we peek behind the curtain at this gaudy return, we find it is skewed massively by coffee's 83.1% gain. Corn is a distant second at 13.2%.  This is the sort of thing that gets stock market technicians yelping about narrow market advances and the like.



We also need to step back, presuming we're not standing near a cliff's edge, and look at the history of the agricultural index's total returns, relative to those for US stocks, as measured by the Russell 3000 Index (INDEXRUSSELL:RUA), seven- to 10-year Treasuries, investment-grade bonds, and high-yield bonds. Instruments such as the PowerShares DB Agricultural Fund (NYSEARCA:DBA) did not exist in January 1991, but the comparative underperformance of the agricultural index should give you food for thought.



Let's just say this index does not scream "buy and hold" as much as it does "chuck and duck." The long-term history is one where upturns arrive swiftly and disappear swiftly, and where the roll yield between futures contracts eats you alive. The old floor traders understood coffee to be a great day-trading instrument and behaved accordingly. Why anyone would want to expose themselves long term to an index dominated by a single commodity is beyond me.
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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