Soft Commodities: Returns & Risks

Coffee, cocoa, sugar

Soft commodities belong to the category of commodities that are foodstuffs such as coffee, cocoa, sugar, corn, wheat, soybean and fruit. Known for their high volatility and extreme sensitivity to natural and geopolitical factors, soft commodities nevertheless, continue to attract an increasing number of investors.

The same market forces that drive up the prices of crude oil and metals also affect the prices of soft commodities. Much of this is demand from emerging economies such as China which are undergoing large-scale industrialisation programmes. This has created new markets for products such as coffee, sugar and similar food products, so much so that by 2030 the United Nations estimates that net imports of food by developing nations will increase fivefold. It seems increasingly likely therefore that the current bull market will continue, as it is also fueled by climate change which can produce devastating effects in terms of famine and drought. Estimates show that just a three degree rise in temperature could put another 400 million people on the poverty line whilst causing cereal crops to fall by 400 million tons.

There are many different opportunities in soft commodities markets but it is important to stress that it can be very speculative and risky. Although there are long-term price trends, trying to time the top or bottom is not an easy task. Commodities can be extremely volatile and it can take extensive research to be able to completely understand their movements. However, you can carry out a valuation using both fundamental and technical analysis to find out about supply and demand as well as trends, entry points and exit points. There are also indexes designed to track the performance of commodities in the market that can be useful to traders. Investing in commodities can be profitable if the trader is well informed and alert to market changes.

Another risk associated with investing in soft commodities, is that commodities are not located in one place. They are spread all over the globe and controlled by the governments and companies of the countries where they are located. You can counteract this risk though by protecting your investment from this geopolitical insecurity by investing only in reputable companies with experience and economies of scale.

Soft commodities offer excellent diversification for a crisis portfolio as they are uncorrelated to the stock market. As commodities have a risk/return profile comparable to stocks and bonds, investing in commodities seems attractive, but the strongest case for including a commodity index to your portfolio is the negative correlation. Commodities have a negative return with traditional stocks and bonds. Negative correlation is when one security’s return moves in the opposite direction to another security. Economic conditions that are good for commodity returns such as unpredicted inflation are more often than not, bad news for stocks and bonds. This analogy is also relevant to geopolitical conditions. A natural disaster or a war may disrupt wheat supplies and lead to higher prices. This is bad for stock and bond returns but encouraging for commodity index returns.

Despite the risks, traders have realised that soft commodity trading can be lucrative and explains why investing in this way is proving increasingly popular. If you are considering investing in soft commodities, you can trade with an experienced broker like Banc De Binary with a view to making a profit on this highly attractive asset class.