Keeping Watch on El Niño

This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. | Washington Business Journal

Recently, in its monthly update, the Climate Prediction Center of the National Weather Service announced that there is a 50 percent chance that El Niño conditions will develop during the second half of 2012, and the Australian Bureau of Meteorology also is seeing climate indicators pointing to El Niño.

El Niño is a period of warm ocean temperatures in the Pacific, and is often associated with heavy rains in Peru and wet weather in the southern portion of the U.S., and with corresponding droughts in Australia and Indonesia.

Commodity traders have noticed this weather trend, and other investors need to pay attention.

The obvious first order effects are on food processing companies and restaurants, which see their costs go up as wheat, soy, rice, and other food prices rise. Second order effects occur as consumers have a larger percentage of income going towards rising food prices rather than other spending, slowing down overall economic growth. Third order effects are seen as climbing food prices cause rising inflation globally, leading to higher interest rates, and potential downward pressure on both bond and stock prices.

El Niño droughts in Australia, which is typically the fourth-largest wheat producer in the world, reduces global wheat levels. And Australia has been lowering its wheat forecast due to possible El Niño effects . El Niño conditions are also associated with weakened monsoons in India (which we have again witnessed this year), harming its agricultural growing season and pressuring prices of rice, soybeans, and sugar.

In major growing areas of southern Brazil, Uruguay and Argentina, above-average rainfall occurs, but usually at the wrong times (sowing and harvesting times), resulting in lower crop production. Indeed, we have seen this effect in Brazil, which has seen its sugar cane harvest disrupted due to heavy rains, with May 2012 output dropping 19 percent in its main sugar cane growing region. This could pressure corn prices, with corn sugar being the major substitute for cane sugar. Additionally, declining sugar cane production leads to declines in ethanol production for Brazil, which pressures U.S. corn prices as both a sugar substitute and an ethanol feedstock.

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