La Niña weather condition map

La Niña is coming: Here’s what it means for commodity markets

MCHENRY, Ill. — If the La Niña weather phenomenon that’s forming in the equatorial Pacific Ocean reaches fruition, be prepared for wild commodity market rides.

La Niña impacts weather patterns worldwide and is associated with cooler, wetter conditions along the U.S.-Canadian border and warmer, drier conditions in much of the southern U.S. The phenomenon is caused by cooler Pacific water.

There’s no guarantee the La Niña will form, but if it does Erik Norland, CME Group executive director and senior economist, is concerned about the current agricultural markets.

“Corn, wheat and soy complex options implied volatilities are trading at or near record lows. This might mean that markets are woefully unprepared for a potential La Niña that would bring a wave of volatility,” he said in an Allendale Inc.-hosted webinar.

There have been eight La Niñas and 12 El Niños since 1959. El Niños tend to be bullish for agricultural prices because it tends to create drought and extreme high temperatures that impact yields.

Under the last eight La Niña episodes, most agricultural prices fell with the exception of rice.

“Wheat has been particularly negatively impacted, corn somewhat negatively impacted and soybeans down maybe 13 percent on average in the 12 months after the La Niña threshold,” Norland said.

No two La Niñas are exactly alike in their degrees of intensity and duration, impact on temperatures and precipitation in the world’s crop growing areas, and the impact also varies by economic circumstances.

The most recent La Niña in 2010 was at a time when the U.S. Federal Reserve was initiating its near-zero rates and quantitative easing policies.

Commodity prices and equities markets soared in 2009 and 2010, rallying prices of most agricultural products along with them, regardless of whatever impact the La Niña might have had.

In addition, agricultural production has soared in South America since the late 1990s, which might mitigate some of the price impacts from a La Niña, which affects the Southern Hemisphere differently, with typically cooler summers in Brazil and drier winters in southern Brazil, Uruguay and northern Argentina.

Opposite Effects

“The thing about La Niña and El Niño for that matter is they tend to have opposite effects in North and South America. So if La Niña makes summers cooler and drier in North America, they can make things warmer and wetter in South America,” Norland said.

“That’s going to add to sort of add to the price disturbance, but also may help balance things out. For example, if one event causes a bad harvest in South America, it may create an exceptionally good harvest in North America or vice versa. So the impact on global prices may not be constant over time, and that could also be one of the reasons why that most recent episode in August 2010 turned out to be not such a big deal, at least for most of the agricultural markets.”

Norland cautioned that just because prices are low doesn’t mean they couldn’t possibly go lower due to high domestic and global corn, wheat and soybean stocks.

“The crux of this is not just that the prices might decline in the event of a La Niña, but that La Niña tends to produce exceptionally high levels of volatility,” he said.

“The more powerful the La Niña, the more likely we are to have exceptionally high levels of volatility in agricultural goods prices. So the truth is we don’t know if this is going to be an exceptionally powerful La Niña.

“We don’t know exactly how it’s going to impact North or South America and possibly impact that in a way that offsets that volatility, maybe producing a bad harvest in one area, but a particularly great harvest in another area. If that turns out to be the case, maybe some of that volatility will go away.

“At this point, we’d be on the side of caution, and so when we look at the implied volatility trading at record low levels for corn, wheat and soy products, it makes us a little bit concerned that maybe people are not looking closely enough at what’s happening in the Pacific and thinking through the potential consequences of that for various agricultural goods markets and particularly for options.

“But it also leads us to believe if one does have to hedge oneself in the market and one’s going to use options to do that, it’s obviously better to buy those options when the prices are low than when they’re potentially much, much higher.”

Source: Tom C. Doran AgriNews Publications