The futures market has a poor history of predicting El Nino-related price increases, a recent study from CME Group found.
Erik Norland, an economist at CME, compared how spot futures contract prices and futures spreads for a variety of commodities behaved in the 12 to 24 months after NOAA’s Climate Prediction Center Oceanic Nino Index signaled the beginning of an El Nino or La Nina.
El Nino describes the warming of the eastern tropical Pacific Ocean that takes place every few years. This alters the tropics’ weather pattern, and can influence many other areas of the world, including the U.S. La Nina is when equatorial Pacific Ocean waters have a sustained period of below-normal temperatures. The prevailing winds generally move east to west, and take moisture westward across the ocean. La Nina has a strong correlation to dry conditions in the southern U.S., including the southwestern Plains hard red winter wheat belt.
“What I think is interesting is the futures market sort of missed El Nino in every previous episode, and never really anticipated the impact,” he told DTN. “If the market was really anticipating that El Nino was going to have a big effect and going to create crop failures, prices in the future should be higher than they are currently, but that’s not generally the case.”
Instead, returns from futures positions were about equal to spot returns.
Norland looked at the impact of each El Nino since 1972 on grain and livestock futures prices and found that the value of agricultural goods generally increased, in inflation-adjusted terms, in the years following El Nino. But he said there’s significant variation from one El Nino to another.
“Sometimes (prices) rise a little bit, sometimes they rise a lot, sometimes they actually decline depending on other factors that can influence the market,” like whether other commodities prices are rising or falling and whether the U.S. dollar is strong or weak, he said.
The exception to generally rising prices is 1997, when spot prices plunged. It’s also the El Nino that Norland thinks is the most similar to the current one, which officially began in June.
The 1997 El Nino was the most intense on record, but it also began during “the same month that the Thai currency, the Thai Bhat, fell off its peg versus the U.S. dollar and was devalued.” That set off a major financial crisis in Asia that culminated in Russia’s default and the collapse of long-term capital management in the U.S.
Prices of other commodities struggled during that timeframe, too. In June 1997, West Texas Intermediate Crude Oil averaged $19.30 per barrel. Twelve months later it had fallen to $13.36 per barrel. Gold prices fell from $339 per ounce to $295 during the same time.
The situation today is similar in the sense that many emerging markets are slowing down or going into recession. China’s moves this week to devalue the yuan, also called the renminbi, and to sell U.S. dollars strengthens the comparison to 1997-98.
“We are now in an emerging markets crisis of sorts,” Norland said. “It’s different than the Asian and Russian … (crises) of 1997 and 1998 in details, but we are seeing a broad-based slowdown in China, stagnation in India outside of government spending, and financial services and outright recession in Latin America, the Middle East and Russia. Moreover, much like in the 1997-98 period, we are seeing a strong dollar. The flipside of a strong dollar is weaker foreign currencies and China’s (belated) decision to devalue the renminbi is an example of this.”
While the 1997 El Nino didn’t boost agricultural prices in U.S. dollar terms, it did make them more expensive to buy from a currency perspective, much like the current market.
Norland stressed that each El Nino is different, and futures prices tend to wait to see how El Nino plays out before pricing in its impact.
“Pacific temperatures, atmospheric indicators and deep-water measurements all point to El Nino being a robust event, well-established, and still intensifying,” DTN Senior Ag Meteorologist Bryce Anderson said. “Forecast models place over 90% odds for El Nino to continue through the 2015-16 winter, with 80% odds of still being around into the spring of 2016. And it’s still intensifying. Some measurements even surpass the 1997 El Nino — Pacific sea surface temperatures in July were in some areas the warmest on record — even warmer than the big El Ninos of 1982-83 and 1997-98. From what I’ve seen, those assessments are not overstating what’s going on.”
A full copy of CME’s report, which includes more lengthy discussions and comparisons of previous El Ninos, can be found here.