Sugar With Your Coffee?: Financials, Fundamentals, and Soft Price Uncertainty

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Covindassamy, Genevre;
Robe, Michel A.;
Wallen, Jonathan
Jun 2016
We investigate empirically the factors related to price uncertainty in the markets for two key Central American commodities: coffee and sugar (“softs”). Specifically, we analyze the predictive power of physical market fundamentals and financial variables with respect to (i) market expectations of future price volatility in the markets for both commodities and (ii) theextent to which these markets co-move with equity markets. We capture commodity market uncertainty through option-implied volatilities. Variables considered on the physical side include global macroeconomic conditions (driving current consumption demand); precautionary and speculative demand (through commodity-specific inventory conditions, as implied by the commodity futures price slope); and idiosyncratic supply shocks (including extreme weather episodes and disease epidemics). The two main variables on the financial side are a proxy for investor “sentiment” or overall uncertainty in financial markets and a measure of the intensity of financial speculation in commodity futures markets. We find that physical market fundamentals (inventories, weather events, diseases) matter. Beyond fundamentals, our results highlight the crucial role of financial market sentiment in understanding cross market linkages and the magnitude of softs market uncertainty. Similarly, increases in financial speculation help predict increases in softs uncertainty. We find qualitatively similar results for cattle, another important Central American export commodity.