Guest Commentary by James Roemer, Meteorologist/Commodity Trading Adviser
In 2015, we saw the Commodities sector endure its biggest annual rout since 2002. This commodity price falloff was led by crude oil, which fell 34%, as well as by natural gas, grains, and many other agricultural commodities, which fell 15%–25%. More recently, El Niño (warm ocean currents in the central Pacific that change global weather patterns) has helped world grain production rebound. While global weather patterns improved this past year, helping soybeans, corn, wheat, and coffee to increased production, the lone stars in the Ag sector were sugar and cocoa, which saw 15%–25% price increases due to El Niño-related weather problems in Africa and Southeast Asia.
Just because the Commodities sector appears cheap, is that a reason to jump right in and buy the entire index hand over fist? While I believe there will be some “shining stars” during 2016, and it makes sense for all investors to have some exposure to a sector so beaten up over the last two years, I am reminded of two important investment maxims from Sir John Templeton: (1) “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell”; (2) The time to buy a commodity is when the short-term owners have finished their selling, and the time to sell is often when short-term owners have finished their buying.
Bull markets in commodities are often led by “hedgers” such as large farmers, commercial grain companies, oil refineries, individual manufacturers, and the private or governmental sectors of various nations trying to procure a particular product (copper, zinc, crude oil, soybeans, etc.) in case of a price rise. For the last two years, an economic slowdown in several countries, combined with generally ideal global weather, has meant there has been little panicky buying by hedgers.
El Niño and My Outlook for Commodities in 2016
El Niño, the world’s biggest climatic phenomenon, is easier to predict than many calamities. But only certain countries and commodities see adverse economic impacts from El Nino. They are in India, Indonesia, Northeast Brazil, and parts of Africa. Other countries are impacted as well but these have the most vulnerability.
El Niño was named after the Christ child in the 1800s by Peruvian fishermen who noticed that global weather patterns changed around Christmas every two to seven years. However, in the last three decades and prior to this past year, there had only been one “super El Niño.” That was in 1997. A study by the IMF and Cambridge University found that the 1997–98 El Niño boosted America’s economy by $15 billion, partly because of higher agricultural yields. Also, the total rise in agricultural incomes in rich countries was greater than the fall in poor ones. On the negative side, the 1997–98 El Niño killed 21,000 people and caused damage to infrastructure worth $36 billion globally.
So how do I determine when a particular commodity has topped or bottomed? I look for changes in global production of commodities and which countries will need to potentially import or export more of a specific product. In the case of the crude oil and metals markets, there is very little influence from weather, but at times global climate can affect them. For example, the super-strong 1997 El Niño event brought droughts to Indonesia and floods to Chilean copper mines. Indonesia sees the biggest percentage decline in GDP due to El Niño, and at times rivers there and elsewhere can be depleted by droughts and cause huge shipping problems in the export channels for nickel and copper, causing these commodities to rise in price.
The record-warm December experienced across the United States and Europe was driven by our current strong El Niño and was a key factor in the 30% fall and early winter sell-off in natural gas and heating oil. With falling rig counts in the US and a major correction in the energy sector, we find a commodity that is potentially way oversold on a 1- to 3-year horizon. There may eventually be some great potential in this market.
Normally, with strong El Nino’s, warm winters continue to pressure natural gas prices. However, there are some other strange climatological changes taking place that may create a floor in this market. An added positive issue is that the United States is now an exporter of liquefied natural gas without any caps on the amount of exports. This is a new and growth industry sector for America.
In the soft commodities, cotton may have the best risk-reward profile, given the fact that farmers are planting less of it globally as they take advantage of higher-priced commodities such as soybeans. Cocoa and sugar crops could still be decimated by some winter and spring El Niño-related weather problems, but I am worried about the high price of cocoa relative to the demand side of the equation in both China and Europe. There is too much optimism in the cocoa market, in my opinion, with El Niño production worries already built into prices.
On the other hand, sugar prices have rallied close to 50% during the last three months, and it has been the strongest commodity since summer. This sugar rally was occasioned by El Niño-related drought in India last summer; production problems in Thailand; and, most recently, incessant wet weather in Brazil. When the weather is too wet in Brazil, rather than exporting raw sugar, sugar producers often use drenched sugar cane for ethanol production. Historically, one year following an El Niño, there is no discernable correlation to sugar prices. Half the time we see global sugar production fall, and the other half of the time there is higher production and steady-to-lower prices. As we get closer to spring and summer we will do research on what the Indian and Thailand monsoon season may bring. That can lead to more confidence as to whether sugar prices could be set for another bull move up.
I have been bearish on the livestock market for months due to the fact that cattle production is finally rebounding after several years of hardship following back-to-back 2011–2012 droughts. Droughts cause higher grain prices, which means it gets too pricy to feed cattle, so ranchers reduce their herds. Lately, the high cost of beef has been affecting consumer demand, while the easing drought out west has allowed ranchers to rebuild their herds, pressuring cattle prices.
The grain market continues to be in a tailspin following back-to-back record global crop years from Asia to the US to South America. El Niño is often a multi-trillion-dollar shot in the arm for corn, wheat, and soybean crops in the US, Argentina, and Brazil. Great rainfall this winter (South American summer) and record planted acreage will likely keep these markets in check, with any appreciable rally unlikely. What would inspire a spring and summer rally in the grain complex? The sudden death of El Niño! The last two times this happened were in the springs of 1988 and 1983, when US grain crops suffered drought stress and grain prices rallied 30–50%. However, I remain cautiously bearish on the grain market unless global weather woes return this spring or summer.
Interestingly enough, gold prices can be somewhat correlated to the Indian monsoon. India (the biggest consumer of gold in the world) has taken measures to spur its citizens to invest more in equities. Also, when millions of farmers have a poor, El Niño-affected monsoon (like last summer’s), they tend to put money under the carpet and not spend it on jewelry. There are many other factors in the gold market, of course, and buying gold as a safe haven is not the guarantee it once was. The weather is only one of many elements influencing the price of gold.
Just because many commodities appear cheap does not mean we are going into a roaring bull market in many of them anytime soon. However, some of the most badly beaten-up markets, such as crude oil, copper, natural gas, and cotton are getting to the point where nibbling from the long side might not be a bad idea, even though crude oil prices could briefly go south of $25-$30 a barrel. Novice investors and some hedge funds are still trying to bottom pick many commodities. This is usually a cardinal sin when investing! Global fundamentals from weather do not justify any appreciable rally in the Commodities sector anytime soon.
Thank you to Jim Roemer for presenting his views of weather-related influences on commodity prices.
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