Grains ETFs Likely To Rise Into 2025 (NYSEARCA:CORN)

In my Q2 market cycle update last month, I argued that the cycle—defined primarily as momentum in corporate earnings per share and cyclical commodities—was reigniting and that small caps and precious metals with industrial utilities (e.g., platinum and silver) were some good places to take advantage of such an upswing. I think grains—corn, wheat, and soybeans—should now be added to this list.

This is based primarily on their having been relatively oversold over the last two years and their having shown signs of real momentum in recent weeks. That is, they have limited downside potential because of their selloff during the downcycle and greater upside potential if the market cycle is reigniting.

Thus, they have the potential to make absolute gains, outperform other commodity classes, and outperform long-term Treasuries. This makes them a good hedge against a potential inflation upswing, as well.

I last wrote about grains in November 2022 in an article entitled “ Grain Prices Look Set To Resume Their Slide”, where I argued, “Prices for grains like soybeans, wheat, and corn are likely to see double-digit declines going into 2024 and will likely underperform gold and Treasuries.”

Grains have indeed underperformed precious metals and even long-term Treasury bonds.

This has likely gone too far, however, and it is time for the process to reverse. In this article, I intend to explain why I think a cyclical bull market in grains might be beginning and why they might outperform other commodities.

Commodity Principles

At the peak of the commodity boom in the spring of 2022, I wrote about the:

[F]ive principles I follow in anticipating movements in commodity markets. The first two relate to long-term (decadal) moves and the last three to cyclical (one to three years) moves. These principles do not translate into simple buy and sell signals, but I think they point to where the preponderance of upside and downside risks may lie.

I will briefly review those five principles and then cross-check them with current conditions. I believe we will find that the long-term risks (to the end of the 2030s) are still to the downside in commodities (but are rising) while cyclical risks are now primarily to the upside.

Principle #1: Real commodity prices track the earnings yield over the long term

Recently, I have been working on an article attempting to demonstrate this more conclusively than I have thus far. One chart from that research appears below. It takes log rates of change in primary commodity prices from1 year to 40 years between 1871 and 2023 and checks their correlations with the corresponding rates of change in S&P Composite EPS times the Consumer Price Index divided by the S&P Composite Price Index.

The correlations are weakest over the shortest-term intervals (1- to 4-year rates of change) but quickly rise to quite considerable levels thereafter.

The underlying rate of consumer inflation is not the main driver in this relationship. This is illustrated in the following chart, which shows the correlations over 40 different rates of change between real commodity prices (spot commodity prices divided by CPI) and the earnings yield for the S&P Composite.

Over every interval, the correlation is above 0.4. It can be observed here in the absolute levels of real commodity prices and the earnings yield.

The theoretical problem this creates is that if commodity prices are driven by the fundamentals of supply and demand, then it would appear that the fundamentals of supply and demand in commodities drive the relationship between stocks and their earnings as well. I think it is likelier that there are fundamental drivers that are more complex and deeper than the textbook abstractions of supply and demand. And, these are likely bound up with socioeconomic dynamics that were first outlined by Kondratiev and Schumpeter a century ago but on which our knowledge has largely regressed under the rule of policy-obsessed economists.

Principles #2: Bear markets in commodity prices last at least 20 years

In my reformulation of Kondratiev (see “ Conjunction & Disruption: Technology, War, And Asset Prices”), I believe, under a fiat monetary standard, commodity prices, especially real commodity prices, undergo 20-year deflationary supercycles every 30 years. The last commodity supercycle ended around 2010 (give or take a year depending on how one weights a commodity index).

It is more probable, therefore, that real commodity prices will remain subdued until the end of the decade.

This does not mean, however, that commodity prices will not rise over the remainder of the decade. If we assume, for example, that PEs are mean-reverting, then it might be necessary for real commodity prices to also be mean-reverting. By that measure, real commodity prices are already extremely depressed. They are somewhere near where they were during the Great Depression (see Chart D).

A modest rise in the long-term rate of commodity inflation combined with the cyclical volatility that is characteristic of commodity prices opens the path, under the right conditions, for significant gains, even during ‘secular’ bear markets.

Principle #3: Commodity prices tend to peak with cyclical growth rates

This principle was worded somewhat poorly in hindsight. It would be better to say that commodity prices and momentum are strongly correlated, and thus, in this instance, commodity prices tend to trough with cyclical growth rates.

For example, one can see below that in an equal-weighted index of corn, wheat, soybeans, and rice prices, nominal prices tend to move with momentum in those prices, and momentum tends to be predictive.

Principle #4: Commodity cycles are correlated with earnings cycles

This is the core of the market cycle. This was already discussed extensively in the quarterly cyclical update (linked to at the beginning of the article), so I will just summarize the latest one by repeating that most core cyclical indicators look as if they are gaining positive momentum.

Grains are somewhat more peripheral to the market cycle than are some other commodity classes, so to anticipate whether or not an upturn in the market cycle will feed into grains prices requires establishing a relationship between the market cycle and the grains cycle. That is left to the fifth principle.

Principle #5: Precious metals lead the commodity cycle

Precious metals typically lead the commodities, because there is typically a certain progression in the market cycle. The following chart illustrates this principle.

Precious metals tend to rise first, followed by industrial commodities (and corporate earnings), which are followed by grains, which are in turn followed by energy and fertilizers. And, within that structure, we can speak of a commodity cycle wherein commodities generally remain correlated with one another.

But, their price ratios shift over the course of the cycle. This is clearest with respect to gold price ratios but can also be seen to a lesser degree in other price ratios. The following chart illustrates this relationship between gold price ratios and commodity performance.

In the case of grains, there is a 0.51 correlation between changes in the gold/grains ratio and the subsequent performance of that hypothetical grains index relative to 10-year Treasuries over the last 50 years. That suggests that the resolution to ‘imbalances’ in the gold/grains ratio are primarily resolved through grains prices, not gold prices.

This relationship can be observed in the following monthly chart, updated to March 2024.

Using a Bollinger band on these fluctuations suggests that, as of March, the gold/grains ratio had moved nearly two standard deviations (100% is equivalent to +2 standard deviations and 0% is -2 standard deviations).

We can take a more granular look using historical data from Stockcharts.com. The following chart shows the gold/wheat ratio in the top panel, rates of change in the ratio in the second panel (in red) along with the 2x standard deviation bounds, and the spot price of wheat in the bottom panel.

This suggests that wheat has been ‘oversold’ relative to gold.

We can do the same for corn.

And with soybeans.

Each of these has become extremely ‘oversold’ relative to gold. (I put “oversold” in scare quotes, because I think this is a natural part of the market cycle rather than a failure on the part of market participants).

These cyclically ‘oversold’ conditions in grains can also be seen relative to industrial metals (which tend to rise after precious metals but before grains) and energy (which tends to come last in the cyclical line).

This is illustrated with corn, below.

The red line shows the S&P Goldman Sachs Industrial Metals price index relative to corn, and the green line shows corn relative to the S&P Goldman Sachs Energy Index. The red line is somewhat high compared to the last decade’s levels, showing how poorly corn has performed, although this is not unusual before a surge in grains prices.

The green line shows, however, that corn has underperformed energy, as well, even though, in a perfectly cyclical world, it should be outperforming. It is only in the last few weeks, in fact, that we have begun to see a possible breakout of grains prices relative to energy. This is due in part to recent weakness in crude oil, particularly, but also due to grains strength.

These patterns are repeated in wheat and soybeans.

In short, the ‘commodity curve’, as I like to call the collective complex of commodity ratios, suggests that grains have been due to rise to repair the ‘dislocation’ in grains prices. The one thing that had been missing is momentum in grains themselves.

Grains Momentum

I look at momentum in a variety of ways, using different statistical techniques as well as relative strength. Different macro contexts often make one technique more useful than another.

For example, under current conditions, where the cycle is more fractured than normal (cyclical commodities have been down but interest rates keep rising), I tend to be skeptical of jumps in more sensitive technical indicators. But, since other commodities, especially gold, have run so far ahead of grains, the latter have more potential upside and thus deserve a greater reliance on sensitive indicators.

Where there is a clear pickup in momentum; therefore, I think there is potential for outperformance against other commodities and Treasuries. (I have no good way of measuring relative performance of equities and commodities, except over supercyclical durations, mediated primarily through the relationships expressed in Chart D).

So, in the following charts I am going to show grains prices relative to the iShares Short Treasury ETF (SHV) and the PIMCO 25+ Year Zero Coupon U.S. Treasury Index Exchange-Traded Fund (ZROZ), as well as the three momentum measures I focus on.

First is corn relative to SHV. The gold, green, and red indicators have slightly different functions, but generally, they run from least sensitive to most. These are all beginning to turn up.

Let’s look at soybeans relative to long-term Treasuries.

This is essentially the same pattern, even though it can be argued that the grains/ZROZ ratios are still quite high. Thus, if this is indeed a trough, it is a high trough. The problem is that with other commodity/Treasury ratios (for example, gold/ZROZ), they are at even more elevated positions.

Let’s look at wheat relative to the iShares 7-10 Year Treasury Bond ETF (IEF), too.

This is effectively the same pattern, across the board.

In short, grains have been underperforming most other major commodity classes, including the key precious metals complex, and Treasuries, and now they are showing momentum.

Grains ETFs

The next question is whether these theses can be translated into trades. Last year, based on similar dynamics as those described in this article, I anticipated a surge in natural gas prices but found that there were no good instruments to express that thesis because of extreme degrees of contango in the natural futures market (see “ Why Natural Gas ETFs Could Disappoint”).

In the grains markets, the futures curve is much flatter.

First, however, let’s talk about the structures of the Teucrium grain ETFs, NYSEARCA:CORN, NYSEARCA:WEAT, and NYSEARCA:SOYB.

Each of the portfolios for corn, wheat, and soybeans consists of three futures contracts traded on the Chicago Board of Trade. The composition of each portfolio typically includes a second-to-expire futures contract, which is weighted at 35%, a third-to-expire contract, which is weighted at 30%, and a contract expiring after the third-to-expire contract, weighted at 35%.

The respective ratios of late-2025 futures to current spot prices suggest that contango is somewhat steeper in wheat (red) while soybeans (green) are in modest backwardation.

If we look at relative performances of each of these grains funds with historical spot prices (as in the following chart), they are inversely correlated with the current relative degrees of contango.

Thus, SOYB is more likely to outperform spot soybean prices than WEAT relative to spot wheat prices.

This has apparently translated into long-term outperformance of the SOYB fund, as shown below.

This is despite a high correlation of spot prices over the same period, as shown below, particularly between wheat and soybeans.

From this perspective, SOYB is likely to outperform CORN, which is likely to outperform WEAT over any reasonable timeframe.

Conclusion

Commodity prices are likely still in a period of relatively depressed returns, especially when compared to the supercycles of the last century. Nonetheless, commodities have a lot of cyclical volatility (one- to two-year timeframes), and one good predictor of future price moves is relative strength along the ‘commodity curve’, especially as it is expressed by the gold/grains ratio. Another good predictor is cyclical momentum.

The gold/grains ratio has surged over the last two years, and this is characteristic of a bottom in the grains cycle. The newfound momentum in grains prices (including relative to Treasury bonds) suggests that the grains cycle has indeed bottomed. Based on a simple historical extrapolation, my estimate is that spot prices in grains will outperform 10-year Treasuries by 35%, give or take 35%, over the next 16 months. Because of backwardation in the soybeans market and a not-inconsiderable degree of contango in the wheat market, SOYB is likely to outperform CORN, while WEAT will come in last among the three.

Because cyclical conditions are in a state of flux at present, it will be important to monitor the momentum in grains markets, including their momentum relative to Treasuries and other commodities, but they are likely to produce significant returns going into 2025. In a period of stretched equity valuations, they may provide a source of uncorrelated returns with relatively low downside risk.