La Nina strikes back in 2012

Some fascinating an in-depth research from Forecast: “Keep an Eye on the Baby”.

The summary:

  • La Nina returns, and is seen persisting through northern hemisphere spring and maybe summer
  • The impacts are well-known after the disastrous effects of the – albeit more severe – 2011 episode
  • Foodstuff prices could again spike further – agriculture index has 30% upside shock risks.
  • Spec players will be attracted by the recent precedent, and by the fact this offers a potential ‘uncorrelated’ risk long to add to an otherwise defensive portfolio (a la 2007 and 2011). Could also spill over more broadly
  • This risks imposing a fresh negative shock to the global economy – could add to s/t EM costs of living hit where weighting is especially high (Asia especially) and again ‘complicate’ EM monetary policy

With everything else going on in the world entering 2012, the weather should be the least of our problems. But with the NOAA suggesting that seas surface temperatures and atmospheric circulation anomalies are consistent with La Nina conditions having returned in the Sep-Nov quarter – and likely to persist through the winter into at least the spring if not the northern hemisphere summer – further weather disruptions could again have some wide unpredictable and wide ranging impacts in coming months.

La Nina’s historical effect on the GS Agriculture Index, particularly soya and corn crops:

Already this year, Argentina has been showing some typical effects impacting Soya and corn crops, and spilling over to wheat prices, while Brazil has seen some volatile weather. This comes at a time when corn stocks are already seen greatly depleted (lowest since 1990s in the US).

Prices have already shown some reflection of the impact and uncertain risks, coming off the lows seen on the generalised commodity crunch periods last year as liquidity impacted the market, but there are dangers of a more extended spike – grains have shown 6mth spikes of between 20 and 60% following on the back of recent la Nina episodes, leaving plenty of headroom on the December bounce, while Soya has seen some particularly outsized spikes even bigger than that.

Overall, the agriculture index is still running modestly negative in terms of the last six months (-5% or so), and the current scale of la Nina being envisaged into the turn of the year would not be out of keeping with something in the order of a 30% jump in the index on average when you look at how much the index has swung over the various scaled events in the noughties. Of course, nothing is predictable in terms of weather impacts from such patterns and spill over onto markets, but on average that is the sort of price impact shock that would be ‘typical’ when you compare recent La Nina readings with their associated price jumps.

And some market strategy:

From a market perspective, this argues that whatever else is going on with ‘risk markets’ and global deleveraging generally, a long agriculture position could make a good potential uncorrelated hedge position that could pay well if the La Nina shock builds. As we saw in 2011, this too could have broader spill over onto wider commodities in general if the food-energy interaction comes into play, and so (akin to previous episodes since 2007) we could see a spell where a cyclically negative commodity view is interrupted by a significant counter-trend ‘negatively driven’ rally, led by foodstuff.

At the same time, if risk markets were to surprise to the upside early 2012, then these commodities would also likely share the move. If the spec market gets the sniff of a strong rally here – and one that has the duel scenario advantage of playing out in negative and positive risk scenarios – then we could see some sharp moves in the futures.

The broader implications of that are also recently in the mind from 2011 – with any further pressure from food inflation (mth/mth, even if yr/yr has favourable base effects) will keep pressure on costs of living and so real incomes / profits, especially in the most high food weighted (Asia) EM regions. That in turn will do nothing to make Asia policy making any less complicated as it already as it seeks to balance needs to avoid a hard landing with what is still the tail end of existing price pressures and the legacy of the post 2008 crisis money expansion and credit splurge.

By spring next year, we would again be seeing food prices as acting as a significant fresh negative for global growth and as a source that compromises the ability of China and co. to ease liquidity too aggressively in the face of the credit tightening and slowdown. This is another risk negative that the global economy could do without and which could ultimately add to the downside risks for all markets including commodities later in the year once any supply shocks are past.

Comments

  1. All well presented….and emphasises the negative effects, but is that entirely relevant from an Australian perspective? While there is some better northern hemisphere ‘normal’ situation against which the La Nina events are a significant deviation, it could be argued that from an Australian perspective, most La Nina events are much more benign, even beneficial (and shorter) in terms of effect on agricultural production than when the pendulum swings in the other direction to the longer El Nino pattern. Bear in mind the extreme La Nina just experienced here with widespread flooding was an atypical combination of sea surface temperature patterns in both Indian and Pacific oceans…the more typical L Nina really represents the time of replenishment for local agriculture (and ecology) bringing much needed rains after protracted hot dry El Nino years.

    • Yep, the Indian Ocean is the missing piece of the puzzle.

      From UNSW: “We have shown that the state of the Indian Ocean is highly important for rainfall and droughts in south-east Australia. More than the variability associated with the El Nino/La Nina cycle in the Pacific Ocean, the Indian Ocean Dipole is the key factor for driving major south-east Australian droughts over the past 120 years.”
      http://www.science.unsw.edu.au/news/indian-ocean-drought/

      On the other hand La Nina etc is important to the global picture. Different regions get affected differently, but global food production systems are becoming increasingly stressed by climate change, peak oil, diversion to bio fuels, urban development, population growth, depleted ground water supplies, … It’s a long list, and it’s not necessarily obvious which limits we’ll hit first, but the system has less and less wriggle room each year.