Kub's Den

When the calendar year 2020 started and people across Asia began to anticipate the Lunar New Year celebrations marking the start of a zodiac "year of the rat," there wasn't necessarily any reason to be concerned. Rats are actually seen as signs of wealth and surplus in Chinese culture -- think of the animals as the thrifty, industrious hoarders they are, with ample pluck and energy and an abundant reproduction rate. Probably a huge portion of the global population was feeling happy and optimistic about the "year of the rat" Lunar New Year celebrations.

Unfortunately, a different sort of feeling started to grip the people of China right when the Lunar New Year celebrations were supposed to start -- fear of a new, strange, not-well-understood virus. Approximately 1.5 billion people in China planned to travel home for Lunar New Year celebrations intended to start last Friday, Jan. 24 and last through this week. Instead, both work and travel has been discouraged, not to mention the Lunar New Year's festivals that have been cancelled. Travel has been outright stopped in Wuhan, Hubei Province, where the outbreak originated. The shutdown could last through Feb. 9 for many Chinese companies.

As far as the market reaction goes, it was the first full week of January when the World Health Organization confirmed that an outbreak of sicknesses in Wuhan came from a novel coronavirus and crude oil futures dropped 5% on Jan. 8. Across other markets, Jan. 14 seems to be date when traders started to price in the risks of a global outbreak, after the second death from the virus and evidence of human-to-human transmission. So far (as of Jan. 28, 2020), more than 47,000 people in China have been placed under quarantine and more than 100 people have died during the outbreak.

There is a great temptation to scoff at this whole phenomenon and the melodramatic media headlines that accompany it -- after all, more people have died from plain old influenza in the past two weeks than from this Wuhan coronavirus outbreak. But from a trading perspective, this new epidemic represents a sudden requirement to recalculate potential price outcomes. By placing even a little more weight on the potential for a catastrophic outcome, like an extended slowdown of the world's second-largest economy, these recalculations can drive consumer commodity prices drastically lower.

Think of how volatility drives options prices higher -- by increasing the likelihood of larger values (gains or losses) further out on the scale of potential outcomes, volatility drives options prices higher. More risk means more need for risk management. This coronavirus isn't well understood -- nobody knows quite what its death rate is and immunologists are hotly debating its possible incubation period and contagion rate, currently thinking that each person infected with coronavirus can infect two to four other people, compared with 1.4 people infected by a typical flu patient. Whatever its characteristics, the Wuhan coronavirus -- like any global epidemic -- will keep fearful people away from their typical business and consumer activities, and therefore, it merits a new pricing of risk in consumer commodities and the companies that rely on them.

Looking at which markets have been most affected, crude oil stands out as a harbinger of global economic activity, and the benchmark West Texas Intermediate crude oil futures have dropped 8% from Jan. 14 to Jan. 28, 2020. Copper, another good indicator of industrial demand, is down 11% over that same time frame.

The Shanghai Composite Index of Chinese stock prices has dropped 4% since Jan. 14, but note that this market hasn't traded since Jan. 23 and will remain closed until Feb. 3, 2020. In the United States, the stock market has also been dinged by this fear of a global epidemic, but as of Tuesday afternoon, the S&P 500 Index is down only seven points since the Jan. 14 benchmark date.

In the agriculture industry, traders certainly take an interest in any potential global slowdown of economic activity, and lower crude oil prices tend to be bearish for ethanol and biofuels prices too. The Baltic Dry Index, a measure of shipping rates for bulk dry goods like grains, has fallen 31% since Jan. 14, which at some times of the year might seem like an extremely alarming indication of a collapse in global commerce -- but in reality, late January always happens to see a sharp seasonal low in shipping rates.

In addition, there is the global soybean trade to consider. Coming off the optimism of the phase-one trade deal between the U.S. and China just two weeks ago, soybean traders might have been expecting to see major announcements of export sales to China just before and just after the Lunar New Year holidays. Now, however, the pace of that business is being thrown into question again, depending on how badly the Chinese economy might be affected by this coronavirus epidemic. Prices for No. 2 soybean futures at the Dalian exchange in China fell 11% between Jan. 14 and the end of trade on Jan. 23. Similarly, soybean futures prices in the United States (down 4% since Jan. 14) and physical soybean prices at the Brazilian port of Paranagua (down 5%) have felt the sudden pessimism.

The trading patterns around this virus epidemic aren't without precedent. When previous outbreaks occurred -- SARS in China in 2003, "swine flu" in Mexico in 2009, Ebola in West Africa in 2014 or Zika in Brazil in 2016 -- the prices on each country's domestic stock market took an immediate hit, as traders priced in the new fear of catastrophic outcomes. However, each market unfailingly recovered within one month of the peak of the outbreak. This time, the year of the rat is just getting started, and perhaps we should have a little more confidence in the tenacious spirit of that wily little critter to pull us through.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.comor on Twitter @elainekub.

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