Talk Your Book: Supply and Demand Always Wins

0:00Today's Animal Spirits is brought to you by Tukrium. Go to Tukrium.com to learn more about their suite of agricultural ETFs at tukrium.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz wealth management may maintain positions in the securities discussed in this podcast.

0:41On today's show, we're joined by Sal Goberti. Sal is the CEO, president, and founder of Tucrium, who's been on the show a bunch over the years. If you were just looking at the agricultural commodities that we're going to talk about today, you would say that, I don't know what you would say. I'm making this up, but you would say that inflation is behind us, if nothing else. Yeah, these things are not, they did scream higher. A lot of them did, but now, and I think Sal has been really helpful for us in helping understand these markets and how cyclical they are and kind of how they work. And the biggest thing he taught us, I remember right when the war started is like, yes, as I say, apply crunch, but farmers around the globe are going to rush to fill that void.

1:22And that's exactly what happened. But just the understanding that these markets are cyclical and supply and demand still drives them. Oh, we didn't ask about this. I wonder if they oversupplied the market. Is that part of the reason why prices have come down as much as they have? But yeah, we're talking things like wheat and corn and soybeans and sugar. And yeah, these things are in a downtrend and have been for many months now. Originally, when the evasion happened, which I think was April 2022. Yeah, March, right around there. The prices of these commodities went vertical. Yeah. And to think that we're about two years removed from that, and I don't know how far each of them are off their peak, is it 50%, whatever it is.

2:03The agricultural commodity world looks a lot different today than it did back then, that's for sure. Yeah, wheat was the one that was most impacted when we talk about that on the show, and that's down nearly 50 % from the highs. Wow. And that's one that had a huge, huge spike. Well, so this should be a lesson. If you went into the rush to buy thinking that prices were going to do one thing, not always the case. It's the old adage, in commodities, high prices help solve high prices, low prices help solve low prices, and it's cyclical, and this is the way it happens. Yes. Okay, so here's our conversation with Sal Gilberti, who is the CEO of Tokrium.

2:40Sal, I'm looking at the prices of corn, wheat, soybean oil, and sugar, and all of them are in a bear market. Weed has been acting much better as of late, but they're all well more than 20 % below their high. The last time that we spoke, you mentioned something along the lines of, I don't want to put words in your mouth, but waiting until these commodities got below the cost of production or something along those lines. Where do these commodities stand today relative to those costs? They're still, in my opinion, they're still 10, 15, maybe even 20 % over those costs. So in that golden grain cycle we've talked about in the past, where things trade flat and sideways at their cost of production in stage one.

3:26In stage two, they go up during some kind of an event, usually a drought. In stage three, they go down. That takes one or two years. We're in the third year of stage three. They're still going down. Well, let me ask you this. You just said that it's in your opinion. I would have guessed that the cost of production is not subjective, that there's some sort of formula involved. What does the, how does, if an investor wants to know, okay, well, I want to wait until they're at the cost of production, where do we find that data? You don't because every farm is different. So my opinion, and again, there are a lot of people saying, look at the old cost of production, futures equivalent.

3:58Look at the futures prices, the front month futures. When that starts going sideways for a long time, you're probably at the cost of production. Take corn between$3.50 and$4 has been its break, futures equivalent break-even price. It trades in that range, you know, goes below$3.50 for a month or two at the most. And then it pops back up. And any event happens, it goes above$4. So, you know, the range is$3.50 to$4. That's futures equivalent break even. And we're at$4.60 spot right now. So sell when it gets above, buy when it gets below? All else equal? Yes, correct. That's pretty much it. And, you know, the cycles are cycles.

4:35They take a while. I think we talked about cycles the last time I was on. And you know where you're at in them. We are on the way down towards break-even. Why I say subjective is a lot of people are saying break-even is now above that$4 mark because of inflation. I don't know. I've been trading, we just figured it out, 42 years. And I think$3.50 to$4 is still a valid spot because things are always overcorrect. So you might say closer to$4. We're at$4.60. Corn's on its way down to$4, I think. So how does inflation impact these agricultural commodities? Because in some ways, they are part of inflation, their input costs, but other input costs obviously impact them.

5:16So what is the relationship there between inflation and the movement of these commodities? Well, the biggest thing, no question, is energy prices and natural gas prices. If natural gas prices are high, then you've got a huge issue because that's where farmers get their fertilizer. So the primary input, the fertilizer cost is natural gas, and then farmers have diesel. They've got seed costs. Seed costs have gone way up, but that's primarily due to genetic engineering, not anything else. It just costs more to produce seeds. So breakeven goes higher, but you get a better yield. So it evens out. Wait, I'm curious to hear you say that it costs more to produce seeds.

5:49I would think that technology is deflationary here like it is everywhere else. Is that not the case? I don't live inside of those companies that produce those GMO seeds, but they keep raising the prices on everybody. So you assume that their costs are higher to do it. What other costs are involved? When you talk about cost of production, what else is in there? Well, so the big ones are basically land values. Obviously, you're either paying rent or you own your land. A farmer that pays rent has some cost in there. You've got your big inputs are fertilizer and seeds. And then you've just got your equipment.

6:23I mean, you're painting down tractors that now are hundreds of thousands or a million dollars for these giant tractors. Farmers have a lot of overhead, a lot of fixed costs, primarily associated with land and equipment and fertilizer, or the variable costs of fertilizer and seeds. You mentioned the energy component of it. Is that the biggest reason that we didn't really have a 1970s style level of inflation yet, where it's just to sustain a level of really high inflation because it was the energy crisis that really did it back then? Or do you think there's a lot more that goes into it than that?

6:55I think you pretty much hit it in a nutshell. I think I think energy, we're managing, you know, there's inflation and everything. But I still say the root cause of inflation, besides obviously too much money chasing too few goods, are energy prices. Energy prices, root of everything. Right. So if people were going to suspect inflation to reaccelerate, one of the bigger reasons for that would probably be rising energy costs. I would say yes. Unequivocally, yes. So I'm looking at crude. And I don't know, it looks sort of range bound. Where do you see the crude markets and how it's impacting the underlying modest view investment.

7:30Last time, I think you said you'd be more surprised if we had 100 before 50. You said 50 is probably coming before 100, right? Right. And I'm sticking with that. So we gave another run up towards 100. I think we touched 90 again since we last spoke six or so months ago. Look at crude's, obviously, it's found a good balance. OPEC has managed to find a good balance with the increases in production in the United States. And the markets are balanced. And between 75 and call it$85 between WTI and Brent. That's where we live. We pop out of it on some news. We go back in. We're just in perfect harmony here.

8:05And unless there's an event, and events, you know, I can't predict them, but unless there's an event that literally disrupts the supply of crude oil, crude's going to touch 50 before 100. Which is crazy to me that the war in Ukraine and a war in the Middle East hasn't sent oil prices just flying higher. I'm actually surprised with the damage that the Ukrainian drones are inflicting on Russian energy infrastructure, I'm actually surprised that we haven't seen energy prices go a little bit higher. Although I think product prices and diesel prices are probably a little bit higher because of that.

8:36So what's the, is it, is it really just the, I talked to someone in the energy industry a couple weeks about this and they said, well, one of the biggest reasons is the U.S. is the biggest producer of oil now. Is that, is that the whole reason? It's a big part of the reason. It's not the whole reason, but the US basically overwhelms any production cuts that OPEC, meaning Saudi Arabia, managed to implement. Saudis are carrying the OPEC cuts right now. So given that, would you throw out any analog, if people were comparing this to any point in history, would you say, well, yeah, but it's not an apples to apples comparison?

9:08It's absolutely not. The United States has never had this dominant position in the global energy markets before. It's a new world in that regard. So how do you view that, the agricultural commodities in light of that information? Does that change any way that you think about it? Or are the cycles still pretty similar in that they're driven by human nature and cost and supply and demand and all that? I think human nature, cost, supply and demand. Supply and demand overwhelms everything. Look, we always go back to it. There's either enough or there's plenty. And right now, there seems to be plenty because we're in these enduring downtrends, except for wheat.

9:40And wheat is a bit of a problem because right now, Russia, the world's largest export of wheat has experienced some pretty nasty weather. They had some very late frosts and they're exceptionally dry. And analysts are reducing their production numbers down by pretty big amounts. In fact, the latest one we heard, the most extreme estimate we heard would basically take the non-China inventories. So global inventories of wheat, less China, because China doesn't export, They only import. So you can't get wheat from China. It might reduce that number by 10 % from the last USDA estimates if some of these private analysts' extreme forecasts about Russian crop deterioration are true.

10:26And that's for next year's crop. Don't forget. There's enough wheat now. But I think there's a pretty big premium built in wheat. So when you're talking about these events, how quickly does that get priced into the market? Oh, my goodness. The moment some analysts put something out, it gets priced in next day, day after. It's quick in grains. I'm curious what impact monetary policy has on your world. Well, on everyone's world, monetary policy is the ultimate arbiter of what happens. I still say too much money chasing too few goods is inflation. That's what it is. I was taught that. I believe that.

11:01And there's a lot of money sloshing around out there. And that is creating, in large part, a lot of this inflation. A lot of this inflation. There's just a lot of money. We're not slowing down. These past few years, it seems like there was all the supply chain stuff and that kind of got ironed out. But it seems like every six months you have another commodity that has a huge spike and it just goes vertical. So you had egg prices went crazy and then cocoa prices this year. And I guess people are now saying orange prices or orange juice prices or whatever. Right. Is this just the par for the course in commodities or is this something that is different in these sort of these cycles where the price just moons?

11:37Is that just how it works here? Because there's so many factors that can impact this stuff really quickly. It's definitely just how it works in commodities. And we I think we got used to an extended period of time just pre-COVID. Year or two pre-COVID, those five to eight years before that, we had pretty stable markets all around. You know, little blips here and there, but markets were stable in commodities. And now you've got weather is not a joke. We do have more extreme weather around the world. You know, orange juice, cocoa, those markets are affected directly by weather. Now, wheat affected directly by weather.

12:13Coffee affected directly by weather. Sugar, cotton, you know, the last year, year and a half, all of those things have been affected by weather events in producing areas. So weather's getting more extreme. And couple that with the growing demand for all of these things. So the supply side becoming a bit more tenuous, let's just say, because of weather. That's a big deal when demand is rising and you're not sure about your supplies. I think that that's why you see these price reactions as the weather events occur. So given the volatility in weather and higher rates, what's investors' appetite for these commodities right now?

12:51We've been seeing outflows, actually. I don't think investors, since we last spoke about six months ago, I think there have been net outflows in almost all the commodities. You see these brief run-ups, especially cocoa and orange juice or two, natural gas of late. But you look at most of the commodity funds out there, they're facing outflows. I think investors, because the stock market's been so resilient, people are not looking at the alternatives. The guys who play commodities are playing commodities. They're in, they're out. The people who invest in commodities are largely invested or waiting, like in grains.

13:25They're waiting to reinvest. and grains are probably 10 % or 15 % or 20 % away from the spot where some fairly big money will move in. Same with oil. You'll see the ETF flows in oil skyrocket when oil finally does head down toward that 50 number. It is funny how it, I mean, this is again, just human nature, but you see a spike in price and then the money comes in probably, right? That's typically how it works. Yeah. Headlines are a big deal and everybody loves rising prices. But how do you how do you educate investors in your funds to understand? Because you always talk to us about how these things are cyclical and kind of waiting for the fat picture, just understanding the dynamics.

14:02So how do you help investors understand when you go through a low period like this and things are going the greatest for these funds? We have open lines of communication. We post on our website, on our social media, what we can to educate people. People sign up for our newsletter, which I think comes out, we try to do it every two weeks. And it's just tidbits of teaching people about the markets. You need to learn about them and you can dive in and invest when you're ready and when you learn more about them. Commodity markets aren't that complicated. I mean, if you're a trader, we used to say at Cargill when I was trading heating oil, we pour heating oil on our cereal in the morning.

14:37We drink it in a glass, mix it with your orange juice. You had to just eat, drink, sleep it all the time. When you're investing for a cyclical gain or you're allocating for some portfolio stability because commodities do stabilize a portfolio when they're used properly. So those are things you just have to teach people and people have to learn. So you mentioned that commodities can act as stabilizers, at least agricultural commodities. And you guys have on your site, one of the show notes, you show the last, I don't know, seven pullback, scratchions, whatever, in the S &P 500 and how the Agricultural Fund Index did during those periods of time.

15:18And each of the last seven times, agricultural commodities outperformed the S &P. Why do you think that is? Because they go to their own drum. I mean, we say it all the time. No one skips their bagel in New York City. Never. Because the stock market goes up or down. I mean, they have their own fundamentals. So a lot of people, it's what we always say, they will wait cyclically, especially the grains. You get those things down at their cost of production, they don't really go much lower. It's only temporary. It's little aberrations. So you put that in your portfolio, it's obviously going to stabilize it.

15:54If it goes nowhere, you put anything in your portfolio that's kind of just sitting there, it's going to stabilize it. And then when the grains move to their own beat, if you get an up move, which is what you get when you're sitting down there at the cost of production, usually, it just looks terrific. And that outperformance, I think, and I'm not looking at the chart we posted, but I'd recommend people go look at it. But I think five of the last seven grains were down. So the stock market was down and grains were down. They both went down. Just grains went down a lot less. I think two of those seven, you're shaking your head, Michael.

16:24I think you could see two of those seven grains actually went up when the stock market went down. So, and I might, I may be wrong. People can go look at the data. No, you're right. You're right. So most recently, stock market was down 10, ags were down one. But interestingly, in the bear market of 22, S &P was down 25, ags were actually up 18, which is, that's a hell of a swing. So I guess within that, I'm curious. So you see the money coming in and out of your funds. How much turnover do you think there is inside of your funds? Do you think that it's people coming in and coming out quickly? Do you think it's people that are strategic in nature?

16:57or they'll say, you know what, I want my ags and they provide diversification or whatever. Like, how do you think investors are using these products? Both ways. It's two different kinds of investors. There are traders that are highly opportunistic and they're trading and they're trading on a headline. So we'll see a lot of money move in on somebody's tweet about our corn or soybean fund or something. We'll see a lot of money move in on the war. OK, we saw that when the war broke out, which is why there was that outperformance in 2022. That was clearly the war. But most times people, the big allocators or the people who are just saying, I'm going to put 1 % in grains or whatever their percentage is, they do it when the price is down.

17:35And then they sit on it until the price goes up. And that takes a while. So there's two different kinds of turnover. The headline trainers, they're fast. A lot of turnover going in, days or weeks, a couple of months at the most. And then you've got the allocators who understand the cycles that last six months or longer. I mean, people had to wait seven years for the last corn rally, and it doubled. It more than that. Speaking of the diversification benefits, I'm sure if you put a little correlation matrix with all the different asset classes, you said mark another own drummer kind of deal. They're not really correlated to anything else, I would imagine.

18:07They correlate a little bit. They're just most commodities are less correlated to stocks than other things. That's kind of how it works. But all the commodities, when we pit them in long-term 20 years against the commodities that are available in ETFs, we used to do a chart of this. I don't know if we still do. Against the S &P 500 correlation, all of them have positive correlation. Some have almost none, like sugar or natural gas, over long periods of time. But others are pretty highly correlated, including the metals, which was surprising to me when I saw it. So, Sal, you've got two ETFs I'm curious to talk about.

18:43the tickers are tags and till. Ben, as in tiller, right, Sal? Is that where you get it from? That's right. It's till, like tilling the field. I was telling Ben on Animal Spirits today that I'm something of a farmer myself. I rented a tiller, so I know all about it. Okay. The question that I have is - It had to be the smallest square footage of tilling that's ever done in mankind. It was 10 by 10. It was 10 by 10. All right. There you go. That needs a tiller. Okay. So as far as I can tell, these are similar strategies. The main difference, correct me if I'm wrong. So the underlying they are investing, It's a diversified basket of corn, wheat, soybean, and sugarcane.

19:15So there's a K1 free option and one that has a K1. Why would one not select the K1 free? Well, most sophisticated investors who are not using an automated system that just puts their money in, say, weekly or every paycheck or whatever, they don't care about the K1. Most people are used to K1s. Their ETF K1s are not your father's dry cleaning K1 where you delay your taxes. It's a little, you know, it's like four pieces of information that comes out on Valentine's Day by PricewaterhouseCoopers. Every year they've hit Valentine's Day. So it's out before your taxes and you get better tax treatment.

19:52So we're not tax advisors. I'm not giving tax advice. But most of our wealthy participants, they actually embrace the K-1 because it's better tax treatment. Now, some people just can't have a K-1. They check the no K-1 box in their automated investing thing. So that's why we came out with Till. and big money goes in and out of till because there are some people who are fairly decent players. They'll put, you know, 10, 20, 50 million in at a time and they go in and out according their own signals. And they wanted a no K1 product. That's why we launched that product. They're slightly different, I must point out.

20:25So the seven out of seven out performance of the stock market is that's TAGS. That's the index that's in the TAGS fund. And that is the fund that gets a K1. Till is slightly different. It's weighted 25 % of each of those big four commodities, these corn, soybeans, wheat, and sugar. But it's more discretionary, and it doesn't buy the underlying funds. It actually buys the underlying futures, and it can pick different futures than maybe the other funds do. But the TAGS index is the one. The index that underlies TAGS, that is the 2-gram agricultural index, and that's the K-1 fund. That's the one that we have the study on where we outperform the stock market.

21:02So you have managed futures investors or tactical investors that are using your fund as a placeholder and just a way to get exposure to these when they're moving up or down or whatever it is. We do know of some people that do that. Remember, ETF issuers, we don't always know who's buying and selling our funds. They either call us and tell us or we see the tax information with a great delay. I know this is not necessarily your beat, but for people that have seen the headlines over the last couple of weeks and months, what the heck was going on with cocoa? So cocoa, it's what, 70 % or 80 % of cocoa is produced in West Africa.

21:33So there are four tiny little countries in West Africa that produce the vast majority of all the cocoa in the world, and they had a bad weather event. So they had poor weather there. And that created a problem. If you lose, you know, with Russia, you had what, 25 or 30 % of the world's wheat exports coming out of Russia, and you had a war and wheat prices kind of doubled. I don't remember off the top of my head, but cocoa more than doubled because you had 80 % of the world's supply is in a concentrated area where they had bad weather. That's a problem. And literally, it's just a weather problem.

22:11It's going away now. Prices are really elevated, but they're on their way back down. They're still very elevated because if you get another bout of bad weather in the next whatever it is, six, eight months, whatever is appropriate for their growing season, a a double whammy could send it to new highs. Now, I don't know that that's ever happened before in cocoa, but people are afraid of it. I mean, if you looked at that market just all by itself, you'd be selling it. You'd be selling with both hands right now. But until it's clear on the crop that's coming out next, the weather event, nobody's going to take a risk and sell that.

22:47When you see spikes like this, just from like the, I don't know how this business works, but in terms of like hedgers versus speculators, the people that can sell these futures contracts, are they taking advantage of this giant spike that you mentioned? I hope so. Any producer that actually has cocoa to deliver, they should be selling into that and locking in their margins. I think anybody who's got confidence in their supply that hasn't hedged or sold out in the future on a cash basis, they're going to sell those futures. Absolutely. But I don't think there are enough of those people to push it back down or the prices would be lower than they are now.

23:19How does shipping fit into all of this? There was massive disruption to our supply chain. Remember all the boats or the ships sitting in the ports of Los Angeles. So the shipping time has normalized. The cost of shipping has come way down. Does that flow through to these underlines or are they completely separated? I think it flows through a little bit. So it flows through less to the producer because the producer pays for higher shipping because they have to discount their crops. So the thing about ag prices is they're so globalized that the end price to the middleman, not the consumer, but the person who's buying corn for processing to go to the consumer, OK, that end price is the price.