A report just released by the Australian Bureau of Meteorology states 2015 sea-surface temperature anomalies in the central Pacific will be the highest in 19 years, are continuing to rise and may surpass the record temperatures set in 1997. El Niño influenced sea surface temperatures are currently 2.9F above normal and are forecast to climb by an additional 4.9F in total by the end of December 2015 and start of 2016.
In response, investors have been fast increasing their exposure to agricultural investments, through indices or exchange-traded funds (ETFs). These saw net inflows of $800m during April and May 2015, in marked contrast to the net outflows of $2.4 billion during Q4 2014.
The warming of sea-surface temperatures in the Pacific leads to misery for a range of countries; hot weather and less rainfall across Asia, Australia and East Africa, but torrential rain and floods in the Americas. The impact of El Niño is bullish for soft commodity prices as the weather extremes distort the production and supply chain for a wide range of commodities such as corn, wheat, rice and palm oil.
Noteworthy is that so far in an El Niño year, prices of many agricultural crops have not yet reacted in response to rising investor interest, and in spite of the expectations of lower harvests/production and reduced stock levels resulting from the impending disruption. The Food and Agriculture Organization (FAO) forecast that rice exports from India, Thailand and Vietnam will decline by 6.2% y-o-y in 2015 to 27.2 million tonnes, while the stock-to-use ratio for the top five exporters, also including Pakistan and the US, will fall 19% y-o-y in 2015/16, the lowest level since 2007/08. Below average rainfall in India and the consequent lower rice production can easily result in prices rising by 10-20% by the end of the year according to traders as governments in China, the Philippines and even as further afield as Nigeria seek to ensure stable consumer prices by retaining the size of their buffer stocks.
Not All Commodities Act in the Same Way
Rice is only one of a number of soft commodities likely to benefit from the current uncertainty. Sugar is forecast to have a global supply deficit in 2015/16, its first one for six years. During 2009’s El Niño, palm oil prices rose 57%.
High weightings and sell-offs in gold, precious metals, and base/industrial metals and of course energy (crude oil and gas) have been responsible for key commodity price indices hitting multi-year lows. A higher dollar makes commodities more expensive in local currency terms; crude oil has now fallen back to $49 a barrel, and gold looks set to break through $1,000/oz. on the downside.
As an asset class, commodities have long been considered useful because of their non-compliant behavior alongside other asset classes. Chinese demand provided a further significant boost at the beginning of the 21st century. Yet the structural slowdown now underway in China, the world’s second largest economy, has split the asset class and is greatly weighing on its constituent parts. On the one side, the country accounts for half of global consumption of copper for use in the power and construction sectors. On the other, as demand slows, so will imports. This is a move underpinned by manufacturing over-capacity. China’s growth continues to ease, and so will prospects for copper and other industrial commodities.
The Trend No Longer China’s Friend
Yet the reemergence of El Niño this year will shift the spotlight onto soft commodities, those essential for day-to-day existence. The world’s population will continue to increase, whatever growth rate assumptions are used, high or low. The pressure on resources is on those areas that can least afford it and will remain vulnerable to adverse conditions.