ETF Securities Commodity Research – Time to short sugar, coffee and soybeans
Summery
Sugar, coffee and soybeans have made spectacular returns this year, but much of their gains have been driven by currency movements, particularly the Brazilian Real.
With record production of Arabica coffee and soybeans expected in 2016/17 and a narrowing deficit in sugar, the rally is likely to come under pressure.
If the Brazilian Real remains stable, we expect fundamentals to prevail and the price of these sugar, coffee and soybeans to decline.
Brazilian Real drives rally
The El Niño weather pattern led to a failed monsoon in India and unseasonably wet weather in South America in 2015/16. However at the time of onset of the adverse weather, the price of sugar, coffee and soy made only muted moves. The sharp depreciation of the Brazilian Real weighed on their performance as stocks of these commodities could be sold in US Dollars, providing millers and farmers with improved margins. When the Brazilian Real started to appreciate we saw the price of the commodities make substantial returns. Year-to-date, sugar, coffee and soybeans have returned 35%, 19% and 25% respectively.
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Weather patterns changing
The El Niño of 2015 was one of the most extreme on record by some measures, but the impacts of the weather phenomenon should be largely behind us now. The National Oceanic and Atmospheric Administration forecasts that the opposite weather phenomenon, La Niña, will emerge by the Northern Hemisphere autumn with a probability of 75%. La Niña involves a cooling of the Pacific Ocean (in a similar manner to El Niño warming the ocean), which changes trade winds and weather patterns from what is considered to be normal. Broadly speaking, areas that were excessively warm and dry in El Niño are likely to turn cool and wet in a La Niña. We assessed the likely impacts of La Niña emerging in autumn/winter (see Opportunity to short agriculture with La Niña) which highlights that the weather phenomenon is likely to be price negative for many crops with the exception of sugar. Cooler Southern Hemisphere temperatures are likely to reduce the heat damage that we have seen in the past crop. Sugar maybe an exception as cooler, wetter weather could reduce the sucrose content of cane in Brazil.
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Record coffee production
After two consecutive years of production decline, coffee output is expected to rebound to an all-time high. Brazil, which produces approximately 45% of global Arabica supplies has seen favourable rain during the flowering of its coffee bushes, setting the scene for a healthy crop. Although the beginning of the harvest has been slowed by rain, current dry and warm weather should allow for field work to catch up. Brazilian output is expected to rise by close to 20% in the current 2016/17 crop.
Elsewhere, production in Honduras (7% of global production) is expected to make a recovery after the planting of ‘rust- resistant’ trees several years ago, which is helping to improve yields. The country has engaged in a renovation programme to protect its coffee from the rust-leaf fungus which has reduced production from Central America and Mexico for the past four years. Honduran production is likely to hit an all-time high of 6.1 mn bags (a 7% gain).
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Narrowing sugar deficit
After 5 consecutive years of sugar surplus, 2015/16 was the first year of a deficit. The failed monsoon in India and Thailand has seen production in these two countries decline the most (the combined output of both countries is about 25% of global production). Production in Brazil (20% of global production) also declined, not because of a decline in cane growth, but because more cane was used for ethanol production.
The 2016/17 cane harvest in Brazil, which is about a quarter complete, is progressing 15% faster than last year’s harvest. With relatively low gasoline prices we don’t expect a large diversion to ethanol this year. Sugar production in Brazil is running 25% ahead of where it was last year and we expect a 7% increase in Brazilian sugar output in 2016/17.
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The Indian monsoon is currently approaching its northern limits and rainfall has been at the long-term average. In contrast to last year, resevoirs will likely be amply replenished. Indian sugar output is likely to rise as a result of more favourable conditions for its cane crop.
Sugar consumption is expected to rise by 1% globally, leaving the market in a production deficit despite the increase in supply. However, that supply deficit will narrow. While sugar stocks will continue to decline, they will remain above the long-term average of 31 million tonnes.
Soybeans head for record production
The Argentine soybean harvest in 2015/16, which is virtually complete, is expected to produce 8% less soybeans that the previous year as flooding in April and May spoiled the crop. Argentina provides approximately 20% of global production. Brazil (30% of global production) has seen its harvest remain close to the previous year’s levels. The 2016/17 year crop for Argentina and Brazil has not yet been planted.
The US 2015/16 crop was a record high. Although USDA projects a decline for 2016/17, we believe that their forecast remains overly conservative. By July 3rd 2016, 22% of the crop was blooming (8% ahead of last year) and 72% of crop was in good or excellent condition (10% better of last year). Moreover, planted acreage of soybean in the US has increased by 1%.
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Speculative positioning in soybean futures stand more than 1.5 standard deviations above the 5-year average, highlighting that investor optimism remains elevated. We believe that the investor optimism is a response to the disappointing Argentine crop of 2015/16. While the 2016/17 Southern Hemisphere crop is not yet in the ground, our analysis of La Niñas indicate that weather conditions could be quite favourable for the crop this year.
Downside risk to Real
While difficult to predict the path of a currency that has been so volatile in the past few years, we believe that the good news about relative political stability (after the impeachment of the President Dilma Rousseff) has been largely priced in. Economic conditions remain challenging for the country and therefore limit significant further appreciation. We believe that currency appreciation will no longer be a meaningful catalyst for price increases in sugar, soybean and coffee for the remainder of this year and the crops will trade on their own fundamentals. Rising production should therefore be price-negative.
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This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
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Gold demand rises with Fed procrastination and Brexit hedging. The Fed is unlikely to raise rates this week according to Fed Fund Futures. Gold reacted positively, gaining a further 4.2% last week as Janet Yellen’s speech virtually confirmed that position. Inflows into gold ETPs increased to US$71.5mn as investors to seek to protect themselves from rising inflation. Cumulative inflows into gold in the first 23 weeks of the year of over US$2bn, mark the strongest flows since inception. Recent polls have indicated that the “leave” camp is marginally outweighing the “remain” camp in the forthcoming UK referendum on EU membership. Demand for gold as a haven asset has risen in light of the potential disruption that the spectre of the UK leaving the EU would cause. Although betting odds provide a better indication of the the outcome (which indicates UK will remain) investors appear to be hedging against worst-case outcomes using gold.
Silver rides higher on gold’s coat-tails. Silver, often viewed as a leveraged play on gold, rose 6.7% last week and silver ETPs saw US$10.3mn of inflows. The gold-silver ratio still remains elevated at 74, considerably above the low of 30 reached in 2011, indicating that silver remains cheap relative to gold. A cyclical recovery driven by continued policy easing by the world’s major central banks will bode well for silver demand as more than 55% of silver’s consumption is from industrial applications. With silver being a by-product of mining for other metals, the deep capex cuts across the mining space is likely to drive another year of a supply deficit in silver.
Investors continue to take profit on oil. Brent rose over US$52/bbl mid last week. A further US$60.8mn was withdrawn from long oil ETPs, marking the ninth consecutive week of outflows, as investors took profit on their gains. Oil prices could face resistance close to US$55/bbl as drilled but uncompleted wells in the US come back on stream. Price weakness maybe temporary as tight oil wells deplete quickly and the spectre of a global supply deficit in Q3 appears realistic as unplanned outages are elevated and the shadow of capex cuts last year bite into supply.
Coffee and sugar rallies drive profit-taking. Unseasonal rain in Brazil has been cited as one of the reasons that coffee and sugar prices rose 8.9% and 9.2% last week. However, we are very early in the harvest and it is likely any field delays can be made up for. The rally in these agricultural commodities has been closely tied to the appreciation of the Brazilian Real, which strengthened to an 11-month high against the US dollar at the appointment of a new central bank head last week. Coffee outflows of US$9mn were the most since October 2014, while sugar outflows of US$2.3mn were last surpassed in January 2016.
Key events to watch this week. Neither the Bank of England, Bank of Japan or Fed are expected to raise rates this week, but investors will poised for cues for further rate moves based on the latter’s summary of economic projections and press conference.
Video Presentation
Nitesh Shah, Research Analyst at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
For more information contact
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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This is a strictly privileged and confidential communication between ETFS UK and its selected client. This communication contains information addressed only to a specific individual and is not intended for distribution to, or use by, any person other than the named addressee. This communication (i) is provided for informational purposes only, (ii) should not be construed in any manner as any solicitation or offer to buy or sell any securities or any related financial instruments, and (iii) should not be construed in any manner as a public offer of any securities or any related financial instruments. If you are not the named addressee, you should not disseminate, distribute or copy this communication. Please notify the sender immediately if you have mistakenly received this communication. When being made within Italy, this communication is for the exclusive use of the ”qualified investors” and its circulation among the public is prohibited.
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This document may contain independent market commentary prepared by ETFS UK based on publicly available information. ETFS UK does not warrant or guarantee the accuracy or correctness of any information contained herein and any opinions related to product or market activity may change. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data.
Any historical performance included in this document may be based on back testing. Back tested performance is purely hypothetical and is provided in this document solely for informational purposes. Back tested data does not represent actual performance and should not be interpreted as an indication of actual or future performance.
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The information contained in this communication is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision.
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Any products referenced in this document are generally aimed at sophisticated, professional and institutional investors. Any decision to invest should be based on the information contained in the prospectus (and any supplements thereto) of the relevant product issue. The price of any securities may go up or down and an investor may not get back the amount invested. Securities may valued in currencies other than those in which there are priced and will be affected by exchange rate movements. Investments in the securities which provide a short and/or leveraged exposure are only suitable for sophisticated, professional and institutional investors who understand leveraged and compounded daily returns and are willing to magnify potential losses by comparison to investments which do not incorporate these strategies. Over periods of greater than one day, investments with a short and/or leveraged exposure do not necessarily provide investors with a return equivalent to a return from the unleveraged long or unleveraged short investments multiplied by the relevant leverage factor. Investors should refer to the section entitled ”Risk Factors” in the relevant prospectus for further details of these and other risks associated with an investment in any securities referenced in this communication.
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Gold ETFs attracted massive flows this week, totalling US$112mn, while gold prices dipped lower. Gold price ended the week lower by 2.6% as the US dollar strengthened after the release of the Federal Reserve minutes on Wednesday. The publication of the minutes of the 26-27 April FOMC meeting revealed that an interest rate hike in June was likely. Following the publication, the odds for a June rate hike (measured as probabilities extracted from the Fed Fund Futures) rose to 30% from 3% before the publication of the minutes. Obviously, FOMC members will have to strive to convince the market of an imminent move and restore confidence lost in March. Risk aversion remains elevated as many investors have taken advantage of the gold price slide to increase their exposure to gold.
Oil ETPs outflows continue on profit taking as prices recover. Oil prices rose 1.5% this week on the expectations for lower US crude inventory and additional oil production disruptions in Canada, Libya and Nigeria. However, the strengthening of the US dollar and the unexpected 1.3mn barrel increase in US crude inventory over the previous week, according to the U.S. Energy Information Administration (EIA), swayed the rally. The temporary supply outages were mostly offset by the increase of US crude inventory which resulted in the sixth consecutive week of profit taking in oil ETPs. Global oil markets remain over-supplied from low winter heating demand in the US and Europe resulting in high inventories, and data from Iran shows oil exports are increasing faster than expected.
Palladium ETPs recorded largest weekly inflows since July 2015. Last week saw US$5.1mn inflows into palladium ETPs as prices lost another 6.9% to US$565/oz. We believe palladium will likely be the outperformer this year. Like platinum, palladium has been in a supply deficit for the past four years and is forecast to remain in deficit for 2016 as demand from the automotive sector is expected to rise 4% this year. Other industrial precious metals also registered positive flows: US$5.7mn for silver and US$1.4mn for platinum.
Coffee ETPs registered outflows of US$10mn, as the price of coffee dropped by nearly 3.3% this week. While the coffee cropping season has just started, the US Department of Agriculture reported that Brazil (the world’s largest coffee producer) will crop 56mn of 60-kg bags this year, up 13% from last year. The prospect of higher supply as well as the depreciation of the Brazilian real against the US dollar explains most of the decline in coffee export prices.
Key events to watch this week. The release of the second estimate of US GDP in the first quarter might be the biggest market mover next week. Market participants expect an upward revision to 0.8%qoq annualised from 0.5% in the first estimate. If we do see this upward revision, the odds for a rate hike in June could rise sharply. The Flash estimates of May PMIs in the US, Europe and Japan, will also be highly followed by market participants. Finally, the first estimate of GDP growth in the first quarter in the UK could trigger market stress in the context of intense Brexit debates.
Video Presentation
Morgane Delledonne, Fixed Income Strategist at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
For more information contact
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
Important Information
General
This communication has been provided by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority.
This is a strictly privileged and confidential communication between ETFS UK and its selected client. This communication contains information addressed only to a specific individual and is not intended for distribution to, or use by, any person other than the named addressee. This communication (i) is provided for informational purposes only, (ii) should not be construed in any manner as any solicitation or offer to buy or sell any securities or any related financial instruments, and (iii) should not be construed in any manner as a public offer of any securities or any related financial instruments. If you are not the named addressee, you should not disseminate, distribute or copy this communication. Please notify the sender immediately if you have mistakenly received this communication. When being made within Italy, this communication is for the exclusive use of the ”qualified investors” and its circulation among the public is prohibited.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This document may contain independent market commentary prepared by ETFS UK based on publicly available information. ETFS UK does not warrant or guarantee the accuracy or correctness of any information contained herein and any opinions related to product or market activity may change. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data.
Any historical performance included in this document may be based on back testing. Back tested performance is purely hypothetical and is provided in this document solely for informational purposes. Back tested data does not represent actual performance and should not be interpreted as an indication of actual or future performance.
Historical performance is not an indication of or a guide to future performance.
The information contained in this communication is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision.
ETFS UK is required by the United Kingdom Financial Conduct Authority (”FCA”) to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
Risk Warnings
Any products referenced in this document are generally aimed at sophisticated, professional and institutional investors. Any decision to invest should be based on the information contained in the prospectus (and any supplements thereto) of the relevant product issue. The price of any securities may go up or down and an investor may not get back the amount invested. Securities may valued in currencies other than those in which there are priced and will be affected by exchange rate movements. Investments in the securities which provide a short and/or leveraged exposure are only suitable for sophisticated, professional and institutional investors who understand leveraged and compounded daily returns and are willing to magnify potential losses by comparison to investments which do not incorporate these strategies. Over periods of greater than one day, investments with a short and/or leveraged exposure do not necessarily provide investors with a return equivalent to a return from the unleveraged long or unleveraged short investments multiplied by the relevant leverage factor. Investors should refer to the section entitled ”Risk Factors” in the relevant prospectus for further details of these and other risks associated with an investment in any securities referenced in this communication.
If you have any questions please contact ETFS UK at +44 20 7448 4330 or info@etfsecurities.com for more information.
A sustained period of high crop prices from 2008 to 2012 led to a bout of investment by agricultural producers, since then falling soft commodity prices have revealed high debt loads and narrowing margins. However the drop in input expenses coupled with a turnaround in sentiment is painting a more optimistic picture for agricultural producers heading into 2016.
Our analysis focusses on the S-net ITG agriculture index, which is diversified across Seeds Chemicals & Fertilizers (53%), Commodity Agricultural Products (30%), Equipment (13%) and Livestock (3%) with 70% of the constituents from the United States.
In the latest farm income outlook released by the United States Department of Agriculture (USDA), US net farm income, a key indicator of U.S. farm well-being, is forecast to decline by 3% in 2016. While this will be the third consecutive year in decline, it is not as severe as the declines of -27% and -38% witnessed in the prior years 2014 and 2015 respectively. Cash receipts are forecast to fall 2.5%, falling prices being the key contributor to this price fall as highlighted in the accompanying chart.
Global nitrogen fertilizer supply is poised to grow as cheap energy prices fuel production increases, providing a boost to their bottom line. Although it is worth noting that the recent squeeze on farmers margins does not eliminate the risk of farmers skipping application of fertiliser or shifting acreage from chemical intensive corn to other crops. We believe the fall in fertiliser costs is likely to benefit both fertiliser producers and farmers.
(Click to enlarge) Source: USDA, Economic Research Service, Farm income and wealth statistics, ETF Securities
Lower expenses buffer slide in cash receipts
Overall farm production expenses are forecast (USDA) to decline for the second consecutive year. Occurrences of multiyear reductions in farm production expenses are rare, the last time being 1984-86. This drop in expenses for inputs such as feed, livestock/ poultry purchases and fuel are forecast to outweigh the increase in interest expenses and hired labour costs thereby alleviating falling cash receipts. More importantly input costs (currently in 2nd year of decline) tend to lag behind commodity price swings (that have been in decline for 4 years).
(Click to enlarge) Source: USDA, Economic Research Service, Farm income and wealth statistics, ETF Securities
In addition, US farmers are poised to benefit from a 31.4% ($13.9bn) increase in direct government farm payments in 2016. The 2014 farm bill eliminated direct payments worth $5bn annually and replaced them with a net suite of safety net programs that will be triggered in 2016 if farm prices continue to fall.
Lower US dollar to benefit exports
Agricultural exports have been a major catalyst for the strong U.S. farm income in prior years, accounting for more than 30% of gross cash farm income. As majority of commodities are priced in US dollars, the appreciation of the dollar against the local currency of non-US growers has made the commodities more expensive for the foreign based buyer. Although its difficult to quantify just how much buyers have been sourcing lower cost soft commodities we have seen anecdotal evidence of this behaviour. For example, Brazil’s soya bean exports surpassing US soya bean exports in 2015 are likely due to the Brazilian Real’s depreciation. We expect a continuation of US Dollar weakness in 2016 benefitting farm income which has been squeezed by recent USD strength.
Outlook for Agricultural commodities
The correlation of agricultural producers with livestock, grains and softs has depicted a cyclical relation over time. Current correlation with livestock remains high at 80%, followed by grains at 64% and lower for softs at 30%.
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Livestock related commodities account for approximately half of the farmer’s cash receipts while the other half comes from crops (namely corn), so farm income would benefit if these specific commodities rise.
Livestock sector ended 2015 as the worst performer among agricultural commodities despite the impact of avian influenza, market prices are expected lower in 2016 according to USDA.
The price outlook for grains – namely corn, wheat and soya bean prices remain subdued since their inventory levels remain are at record highs.
Sugar prices are expected higher owing to the reduced sugar supply from Brazil and India driving expectations for a larger world market deficit in 2015/16.
Dry conditions emanating from the El Nino coupled with a rebound in the real is lending buoyancy to Arabica coffee prices in 2016.
Cocoa is forecasted to be in a supply deficit in 2016.
While cotton has been negatively impacted from lower import demand into China, the crop is expected to remain in a deficit this year.
Shift in sentiment signals an opportunity
Despite the pessimism surrounding the agriculture industry, agricultural producers are currently trading at 20x earnings and 3x book value, in line with their respective 10-year average. Profitability of these companies has been volatile given their exposure to the vagaries of the weather. We are currently in one of the most extreme El Niño events on record, dating back to 1950. According to the Australian Bureau of Meteorology, out of the past 26 El Niño events since 1900 approximately 40% have been followed by a La Niña. If this came to pass, wheat, corn, soybeans, coffee and cocoa will benefit from favourable weather thereby negatively impacting prices while sugar prices will benefit on the upside.
Net profit margins have been in a downward trend since the slump in commodity prices ensued in 2011 but the last quarter in 2015 has seen an uptick of 3.1% over the prior year. Net debt to assets remains high at 31x. USDA has reported growth in farm real estate loan volumes throughout 2015, commercial banks and the farm credit system has remained cooperative and credit to the sector has not been curtailed until now.
Our sentiment indicator (based on consensus data) has been rising since 2014, highlighting a renewed sign of optimism in holding agriculture producer stocks.
(Click to enlarge) Source: Bloomberg, ETF Securities
In summary we believe agricultural producers are modestly valued, with profitability starting to turn the corner in-line with shifting positive sentiment. Despite the pessimism that permeates through the farming industry, farm income credit has not been curtailed. While net farm income is forecast to decline for the third consecutive year, the lag in declining expenses is expected to catch up and help alleviate the decline. 2016 has seen a positive turnaround for majority of commodities and is lending support for the price outlook of agricultural commodities.
Important Information
General
This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value. This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise.
ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
ETF Securities Commodities Research – Opportunity to short agriculture with La Niña
Crop production may increase if La Niña starts in winter
Summary
As El Niño fades, La Niña weather conditions look increasingly likely to emerge later in the year.
La Niñas that reach a “medium” strength by northern hemisphere winter tend to help the production of grains, coffee and cocoa and so a La Niña starting in winter 2016/17 could be price negative.
Should La Niña be delayed to spring/summer 2017, we could see mainly price positive developments.
From El Niño to La Niña
We are currently in the one of the most extreme El Niño events on record (with records dating back to 1950). El Niño refers to the warm phase of the El Niño-Southern Oscillation (ENSO) which is a scientific term that describes the fluctuations in temperature between the ocean and atmosphere in the east-central Equatorial Pacific. The warm phase of the ENSO has led to droughts in Asia and excess rain in South America, leading to a 50% rally in sugar prices between August and December 2015 for example.
According to the Australian Bureau of Meteorology, out of the past 26 El Niño events since 1900 approximately 40% have been followed by a La Niña, the cold phase of ENSO. The International Research Institute for Climate and Society’si regression models peg the probability of a La Niña event at 53% by September.
(Click to enlarge) La Niña tends to have the opposite effect of El Niño: places with droughts under El Niño tend to have excess rain under La Niña and vice-versa.
(Click to enlarge) Source: National Oceanic and Atmospheric Organization
Our analysis of previous ENSO cycles identifies nine distinct La Niña events of a medium magnitudeii since 1959 (8 for coffee since 1972 and 6 for soybean oil since 1979 due to lack of price availability). We look at how commodity prices have performed one year from the date a certain threshold of La Niña intensity has been reached. At a first glance it appears as if there is no clear directional impact from La Niña events. For most commodities there have been a similar number of price-positive events as price negative.
(Click to enlarge)
Summer La Niña vs. Winter La Niña
However, a key distinguishing feature between these nine events is when the La Niña started (or more accurately when it reaches our threshold intensity). We see a clear pattern that La Niñas that reach threshold intensity in the northern hemisphere winter, drive prices of most agricultural commodities lower within one year of the event. The notable exception is sugar. La Niñas that reach threshold intensity in the northern hemisphere summer, drive prices of most agricultural commodities higher within one year of the event. Soybean is an exception here. Summer La Niñas tend to have a more substantial price impact, reflecting the fact that more northern hemisphere crops are in the ground and therefore exposed to weather changes.
(Click to enlarge) Based on NOAA model forecasts of a greater than 50% probability of La Niña starting in northern hemisphere Autumn, we could hit threshold intensity by winter 2016.
Looking at past price trends has limitations. We are not accounting for length or amplitude of each weather event. Nor are we conditioning for other drivers of price including: planting decisions, competing weather patterns, crop infections, starting stocks and currency movements.
Crop cycle and weather impacts by geography
Looking at the crop cycle and weather impacts at different times of the year in various geographies, we believe there is a logical reason why prices should rise or fall in a winter La Niña. The table below is a summary of our findings. We believe that if a winter La Niña 2016 is confirmed, there is good reason to short wheat, corn, soybeans, coffee and cocoa and go long sugar.
At meteorologists’ mercy
We caution investors however, to wait for a confirmation that the weather pattern will emerge as early as winter 2016/17. If the weather event is delayed until spring/summer 2017, then the price impacts could be very different. Remember, the El Niño expected in 2014 did not emerge until 2015. In the meantime, lingering weather impacts from El Niño could provide upside price risks for cocoa in the short-term as the market has underestimated the impact of dryness on the mid-crop which will be harvested from May in most of Africa. Cocoa prices have fallen more than 20% since December as the market has focused on ample port deliveries failing to recognise that supply overall this year could be tight.
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i The organisation that jointly produces the official US meteorological forecasts with the National Oceanic and Atmospheric Organization. The official forecast is based on a consensus of forecasters and committee discussion. The probability from the regression is a purely objective input to the discussion.
ii We use an Oceanic Niño Index (ONI) of less than or equal to -1° to identify a “medium” La Niño event. The ONI is based on Sea Surface Temperature (SST) departures in a specific region of the Pacific Ocean away from its 30-year average. While a La Niña event is technically marked by a ONI of less than or equal to -0.5°, we have chosen to look at medium intensity of -1°, to judge events of significant strength and reduce spurious analysis. We call this the “threshold intensity” for the purpose of this article.
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