Commodities: Continued Food Price Inflation in an Uncertain Market

Widespread droughts, increasing input costs and the war in Ukraine have put record-high pressure on food commodities for the past two years.

Ocean freight costs nearly tripled [1] from 2020 to 2021 and have remained high into 2022. That, in addition to shifts in rainfall and temperature as well as a labor shortage triggered by the pandemic and stricter restrictions on migration are straining the world’s food producers. Migration restrictions are a contributing factor to the labor shortage in agriculture, as per Reuters.[2]

While food production has recovered somewhat in the second half of 2022, pressures are likely to continue. This has some investors looking to potentially diversify into commodities with the goal to generate yield from rising food prices as a potential hedge against a weakened equities market. Here are some of the trends we believe investors should be monitoring to find potential trade opportunities.

Coffee Prices Will Probably Continue Trending Upward but likely to Remain Volatile

According to the International Coffee Organization (ICO), the main intergovernmental organization for coffee, the price of green coffee beans rose nearly 25% year-over-year from $1.60 per pound to $1.99. Meanwhile, total exports shrunk by 3.7% as drought across most of Africa’s major coffee-producing regions and unfavorable weather across South America significantly impacted crop yield. [3]

The ICO expects global demand to exceed production by at least 3.1 million bags, likely keeping prices trending upward into 2023. At the same time, the coffee futures market is becoming increasingly volatile, especially in the United States where intra-day volatility peaked at 11.2% in September. [3]

For bullish investors, that volatility combined with what appears to be an overall upward trend in coffee prices may potentially provide a lot of tradeable price movements but also increased risk from rapid price fluctuations. 

Uneven Recovery From African Swine Fever Could Keep Lean Hog Prices Rising

Pig farmers around the globe have been grappling with an outbreak of the highly infectious African Swine Fever (ASF) since 2018. While harmless to humans, the disease spreads quickly and survives in frozen meat, clothing and vehicles for up to 1,000 days, making it easy to accidentally cross into new territory.

Since the outbreak began, an estimated 100 million pigs have been lost across China, the European Union (EU) and other major pig producing countries. While China, Brazil and some other pig-producing regions have finally managed to get the ASF outbreak under control, the EU is still struggling to contain the spread. The partial containment of ASF could help stabilize rising lean hog prices, but investors should likely expect fluctuations to continue as it is expected that it will take time to recover production rates after the massive loss of pigs.

Corn Production Is Forecasted to Drop Across Three Major Corn-Exporting Regions

Corn production is heavily concentrated among its major producers. The United States is the largest producer in the world, followed by China, Brazil, Argentina and Ukraine. Of those top-producing countries, many are seeing significant decreases in production. The conflict in Ukraine has resulted in crop loss and decreased production while the U.S. and Argentina have been dealing with low crop yields.

The Food and Agricultural Organization (FAO) forecasts [4] a drop in exports as a result that would constrain the market and as a result is likely to keep prices of the staple crop trending upward well into 2023.

Direxion’s Breakfast ETF Helps Investors Gain Exposure to Food Commodities

With the expectation of prices to likely rise across many categories, a potential trade for investors to consider is with an exchange-traded fund (ETF) that offers exposure to a combination of commodities, like Direxion’s Breakfast Commodities Strategy ETF (NYSEARCA: BRKY).

Commodities ETFs are funds that are made up of futures or asset-backed contracts that track one or several commodities. In this case, BRKY tracks the S&P GSCI Dynamic Roll Breakfast (OJ 5% Capped) Index* which was created specifically for this ETF and contains a basket of six food staples that make up the most important meal of the day. Since one cannot directly invest in an index, ETFs aim to track their underlying indexes as closely as possible so that traders can use the fund as a way to trade their assumptions about the index.

Each food-related commodity is weighted based on world production, with the exception of frozen concentrate orange juice, which is capped at about 5%. The index’s holdings, as of 09/30/2022, and the weight of each are as follows:

Holdings are subject to risk and change.

With this ETF, investors may potentially generate yield from exposure to food staples, the demand for which is likely to remain steadier than less essential commodities. Futures contracts* in the Fund are rolled monthly so that the ETF can closely track the current prices of the Index’s underlying commodities.

Forecasts are inherently limited and should not be relied upon when making investment decisions.  There is no guarantee the sector will experience projected growth. In addition, there is no guarantee it will translate to positive fund performance.

[1] https://www.reuters.com/business/retail-consumer/why-are-food-prices-going-up-key-questions-answered-2022-05-10/

[2] https://insights.s-rminform.com/rising-food-prices

[3] https://www.ico.org/documents/cy2021-22/cmr-0922-e.pdf

[4] https://www.fao.org/documents/card/en/c/cb9427en/

*Definitions:

- The S&P GSCI Dynamic Roll Breakfast (OJ 5% Capped) Index measures the performance of tradeable commodities considered to be breakfast foods (corn, coffee, lean hogs, sugar, Chicago wheat and orange juice) by investing in monthly futures contracts for such commodities. The Index is world production weighted and designed to reflect the relative significance of each of the commodities to the world economy, except for orange juice which is capped at 5%. One cannot directly invest in an index.

- A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future.

An investor should carefully consider the Fund’s investment objective, risks, charges, and expenses before investing. The Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain the Fund’s prospectus and summary prospectus call 866-476-7523 or visit our website at direxion.com. The Fund’s prospectus and summary prospectus should be read carefully before investing.

Direxion Shares ETF Risks – An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated with concentration that results from the Fund’s investments in a particular industry, sector, or geographic region which can result in increased volatility. The Fund’s use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of the Fund include Index Correlation Risk, Index Strategy Risk, Derivatives Risk, Commodity-Linked Derivatives Risk, Futures Strategy Risk, Breakfast Commodities Risk, Agriculture Investment Risk, Market Risk, Counterparty Risk, Cash Transaction Risk, Subsidiary Investment Risk, Interest Rate Risk, and Tax Risk. Please see the summary and full prospectuses for a more complete description of these and other risks of the Fund.

Exchange-traded commodity futures contracts generally are volatile and are not suitable for all investors. The value of a commodity-linked derivative investment typically is based upon the price movements of a physical commodity and may be affected by changes in overall market movements, volatility of the index, changes in interest rates, or factors affecting a particular industry or commodity, such as global pandemics, weather and other natural disasters, changes in supply and production, embargoes, tariffs and international economic, political and regulatory developments and changes in speculators' and/or investors' demand. Commodity-linked derivatives also may be subject to credit and interest rate risks that in general affect the value of debt securities. The Fund’s investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in securities or other investments.

Risks associated with the use of futures contracts are (a) the imperfect correlation between the change in market value of the instruments held by the Fund and the price of the futures contract; (b) possible lack of a liquid secondary market for a futures contract and the resulting inability to close a futures contract when desired; (c) losses caused by unanticipated market movements, which are potentially unlimited; (d) the Index’s inability to predict correctly the direction of securities prices, interest rates, currency exchange rates and other economic factors; (e) the possibility that the counterparty will default in the performance of its obligations; and (f) if the Fund has insufficient cash, it may have to sell securities or financial instruments from its portfolio to meet daily variation margin requirements, which may lead to the Fund selling securities or financial instruments at a time when it may be disadvantageous to do so.

Distributor: Foreside Fund Services, LLC.