Just because an asset is out of favour doesn’t mean it’s time to buy. But when the price of a market falls to historically extreme levels, the smart money starts watching very closely.
In recent months, gold and silver have been hogging the spotlight in the world of commodities. And their prices may continue to rise. In contrast, copper and wheat are about as out of favour as you can get. As the chart below shows, gold, silver and commodities in general have been rising this year. But wheat and copper have been flat or falling.
Which, if you’re a contrarian, is a good thing.
History shows us that when a market or investment gets extremely unpopular, or “oversold,” its prices tend to return to average over time. This is called “mean reversion.”
We’ve written about mean reversion before. In mean reversion, extreme, random events may result in prices (or valuations) rising or falling sharply – but prices eventually always return to the mean, or the average, over time. They behave like a rubber band that is stretched too far in one direction, and at some point they always snap back.
And this brings us to copper and wheat.
Copper prices are 27 percent below average
Copper is sensitive to the global economy because it is an industrial metal used in manufacturing things we all use everyday. So, if the demand for cars, phones and construction slows, copper prices tend to fall. And this is what’s been happening recently – there isn’t enough demand for the things made using copper, so there has been too much copper available. When that happens, prices fall.
But the prices may have fallen too far for too long. A mean-reversion trade may be setting up for patient investors.
The following chart shows copper prices compared to their 60-month (5-year) average price (60 MA), also called the moving average. As it shows, when copper prices trade significantly above or below this long-term moving average, they tend to eventually revert back to the mean, or average.
Over the past 25 years, there have been three times when copper prices traded well below average – in December 1998, when copper traded about 38 percent below its 60 MA; during the market turmoil of December 2008, when copper was about 50 percent below its 60 MA; and most recently, in January of this year, when copper at one point traded about 40 percent below its 60 MA. And it is still about 30 percent below its long-term average price.
In 1998 and 2008, buying copper and patiently waiting to sell when it traded back to its 60 MA would have made you money. For example, the 2008 trade gained over 110 percent in six months.
It’s also worth noting that copper prices have traded in a narrow range over the last eight months or so. This usually means that supply and demand have moved into balance. Buyers are matching sellers – so there may already be investors buying copper in the hopes of a mean reversion rally.
Why copper prices might rally
A number of copper mining companies have cut back on the amount of copper they’re producing. This means there will be less copper supply. And the International Copper Study Group (ICSG), has forecast that there will be more demand for copper than supply this year, which will help copper prices. So now may be an excellent copper entry point. Just don’t forget to set up a trailing stop to prevent massive losses just in case copper prices suddenly fall.
Wheat prices are also well below average
And then there’s wheat, another commodity many people use every day. It’s in everything from muffins to beer to soya sauce. Like copper, wheat is seriously out of favour, reflected by its extreme discount to its 60-month moving average.
Based on the current cash price of hard red wheat, it’s 37 percent below its 60 MA. That would make the commodity more long-term oversold than at any time in the last 25 years.
There’s a good reason wheat prices are so low
Aside from simple reversion to the mean, it’s difficult to say what might spark a rally in wheat. Like copper, wheat prices, along with just about every other type of grain, climbed dramatically in the mid-2000s. This was when China, India, Russia, Brazil and other emerging economies were booming. This resulted in higher demand, and prices, for food like wheat and corn and soybeans, because many of these countries could not produce enough to meet the demand coming from their increasingly well-off populations.
But one thing about wheat is that it is resilient and can be grown just about anywhere. So many of these same countries started developing or improving their agricultural industries.
At the same time, countries like Brazil and Russia started producing more wheat – way more than they needed. This meant they had more to export than before. In fact, the U.S. was for decades called the “world’s breadbasket” because it was the top wheat exporter. But it is now the world’s fourth-largest wheat exporter – behind Russia, the EU and Canada.
U.S. dollar strength (which means other currencies are weaker) isn’t helping wheat prices either. Russia, Argentina, Brazil and other big agricultural producers have seen their currencies weaken against the U.S. dollar. But even with weaker currencies, farming is still profitable for local farmers. And weaker currencies make the wheat, corn and soybeans they produce more attractive to foreign buyers. This means there is more, cheaper wheat available and this keeps wheat prices down.
All of this has resulted in record levels of wheat stockpiles around the world. This is one of the reasons consultancy firm AgResource says the agricultural bear market could last another 3 to 5 years.
Why wheat prices might rally
But such bearish viewpoints are why mean reversion works. When the universe of wheat investors all become bearish and sell, soon there are no more anxious sellers. With selling pressure gone, prices are likely to mean revert higher.
There is a bullish story developing for wheat: Over the past two years wheat farmers in the U.S. have removed about 5 million acres out of production from a total 60 million acres. With low prices and lower productivity per acre than corn or soybeans, it often makes good business sense to grow less wheat in the U.S. right now. If that trend takes hold in other big wheat producing countries, there could be a sudden drop in wheat supply.
So, copper and wheat have been out of favour for years. And recent selling has driven their prices to fresh lows. Many investors view the two commodities as dead money. High-flyers like gold and silver are attracting all the attention. But contrarians would be wise to have copper and wheat on their radar.
One of the best ways for the average investor to invest in copper is to own a copper mining ETF. One example is the Global X Copper Miners ETF (New York Stock Exchange; ticker: COPX). It tracks the Solactive Global Copper Miners Total Return Index, which is a basket of some of the world’s top copper mining companies. When copper prices rise, copper mining companies will become more profitable.
To invest in wheat, you can look into the Teucrium Wheat Fund (New York Stock Exchange; ticker: WEAT). It gives you exposure to wheat prices by owning wheat futures contracts. Because of this, it is a little more complex than a regular ETF, so make sure you understand the pricing and tax consequences before you buy.