On June 1, 2012 our TrendCharts Trading Model generated a Bearish Buy Signal for soft commodities as tracked by the iPath Dow Jones-UBS Agriculture Sub-Index Total Return ETN (NYSEARCA:JJA ).

JJA is currently composed of seven future contracts on the following agricultural commodities: soybean, corn, wheat, sugar, soybean oil, coffee, cotton.

Soybean, corn, wheat, and sugar represent 75% of the weighting for the ETN.

JJA closed below its $50.00 support level this week triggering our Bearish Buy Signal — this was a support level that held twice in November and December of last year. With the $50.00 support level broken the next level of technical support does not appear until the $45.00 level.

If $45.00 does not hold then the next technical support level does not appear until $39.00.

Two questions arise from the above visual:

1. Why are prices for wheat, corn, sugar, and soybeans weakening?
2. What are the implications of this apparent bearish trend in soft commodity prices for the global economy?

Why are prices falling?

There are two major factors that effect the price of agricultural commodities:

1. supply/demand dynamics
2. the weather

Like any other commodity when supply outstrips demand, prices fall, and vice versa, but unlike other commodities such as copper, gold, silver, oil and natural gas, the weather plays a major role in soft commodity prices. An unexpected drought can kill off crops and completely change the supply/demand dynamics and send prices soaring; better-than-expected weather can swell the fields and unexpectedly increase projected crop yields for the season, driving prices lower. This uncontrollable and unpredictable variable has made the trading life of some soft commodity traders brutal and short.

Trying to predict soft commodity prices by sifting through government crop reports and weather forecasts is a daunting task.

Another factor that makes price predictions extremely difficult for soft commodities is the global nature of the supply: for example, wheat is grown on every continent on the planet. How can anyone keep an accurate tally of how wheat crops are fairing in the US, Canada, Argentina, Russia, France, Egypt, China, Australia etc.

For a glimpse at the madness that is soft commodity price forecasting, click on the following articles.

The general market consensus is that there is an ample global supply of corn, wheat and sugar. But this consensus view can be changed by one weather system. Soybean supply has been strained by droughts in South America but this has not saved it from the downdraft in prices over the last six weeks.

At TrendCharts, as technical analysts, we resort to looking at the price of an ETN on a chart in an attempt to profit from the future price movement of the underlying commodity.

Is looking at a price on a chart any less reliable than looking at crop reports from the Russian government or trying to predict the weather patterns over the Volga region in Southern Russia? We think not. We believe that the price reflects not only the underlying supply/demand dynamics of the commodity but also the prevailing macro-economic market sentiment.

Let’s examine the recent price action for the top four JJA holdings.

Wheat has dropped 11.8% from May 18 to June 1.

Sugar has dropped 23.6% from March 23 to June 1.

Corn has dropped 22.1% from March 19 to June 1.

Soybeans have dropped 10.0% from April 27 to June 1.

What are these price declines telling us about the global economy?

These steep price declines over such short time periods suggest something more than a change in supply/demand dynamics or the effects of the weather on crop yields: these price declines are the grumblings of the deflation monster.

When deflationary fear grips the capital markets fundamental factors such as supply/demand dynamics for commodities are thrown out the proverbial window.

If the deflation monster continues to terrorize global capital markets soft commodities can fall significantly from their current levels.

Take a look at the five-year charts for the spot prices for corn and sugar; we are long way from the lows hit during the 2008 financial crisis:

Corn — Spot Price

Sugar — Spot Price

Now compare the above two charts to the five-year chart of the SP500:

SP500 Large Cap Index

Note that both Corn and Sugar have broken below their 2011 technical support levels; the SP500 has not.

This tells us that the soft commodities may be acting as a leading indicator pointing to lower equity prices.

If the SP500 does continue to fall and breaks below its 2011 support level of 1,150, the decline in soft commodity prices will accelerate to the downside as all hope of rising asset prices will vanish from global capital markets.

But what if the capital markets are wrong? What if they are overreacting to deflationary risks, and prices stabilize at current levels and start to rise again on more bullish market sentiment regarding global economic growth? (Improving US economic data or a new plan to save Europe).

Well, then we will got stopped out of our SHORT position on JJA, and live to trade another day. At TrendCharts every single one of our trades has an Exit Signal price that is designed to limit the losses on trades that move against us (our current Exit Signal for this trade is a weekly close above $52.75 for JJA; note that the Exit Signal price will change weekly depending on the price movement of JJA).

For now we are SHORT soft commodities, and we’ll remain SHORT until the markets prove us wrong.