El Niño, Neutral and La Nina… The three newest BetaShares ETFs? Not quite. These are the three phases of the El Niño–Southern Oscillation (ENSO). Back in October last year, my colleague and Chief Economist at BetaShares – David Bassanese, discussed the impacts the phase of El Niño can have on the Australian economy and on commodity prices.
Now, nine months down the track with the winter chill firmly in the air, umbrellas at the ready and destructive storm damage wreaking havoc on the east of Australia, it is an opportune time to ask: what phase of ENSO are we now in and what are the potential impacts for Agricultural commodity markets?
Firstly let’s recap the three phases of the ENSO:
- El Niño (‘The Male’) – this is a weather condition that occurs when the water temperatures around the equator off the coast of Central and the top of South America begin to warm due to atmospheric conditions. El Niño is associated with droughts and extreme warm temperatures in our part of the world whilst the northern hemisphere experiences wetter conditions.
- Neutral – as the term implies – associated with average sea temperatures across the Pacific.
- La Nina (‘The Female’) – when El Niño reverses and the water temperatures around the equator begin to cool this brings cooler and wetter conditions to our part of the world whilst parts of the northern hemisphere experience drought like conditions.
Despite the subsequent impact that El Niño can have on global commodity prices, it’s actually La Nina that can have a more severe impact on agricultural commodities and, whilst not always the case, historically La Nina follows on from an El Niño event.
The Australian Bureau of Meteorology (BOM) and the US Department of Agriculture (USDA) both agree that we are now out of the El Niño cycle – although not yet into La Nina. Rather, we are in the Neutral cycle at the moment. However, we are on ‘La Nina Watch’, with the BOM predicting at least a 50% probability and the USDA a 75% probability that we are now entering into a La Nina cycle. Since 1950, there have been 24 world El Niño events and 20 of these have turned into La Nina (Null, J., 2016).
How can La Nina impact Agricultural commodities?
The main impact is on grain production, with dry conditions, far more severe than usual in the US and South America (Brazil and Argentina of main relevance), greatly reducing yields on corn, soybeans, wheat, sugar, cotton and coffee. Historically, when El Niño has turned into its little sister – La Nina – the prices of these commodities have risen. One of the more recent La Nina episodes was the double event that occurred 2010 – 2012, when the US suffered a crippling drought that resulted in a disastrous drop in wheat, soybean and corn production in the grain belt of the US, which in turn saw wheat futures in the US spike 21%, Soybeans up 39%, Corn over 50% and Sugar up 67%.
The past three years have seen excellent growing conditions for grain producers, especially so in the northern hemisphere (Europe in particular) and this has resulted in spikes in inventory levels, resulting in a glut of agricultural commodities which in turn has seen a bear market for this asset class due to low prices. For US farmers at the moment, spot prices for corn, soybeans, wheat and cotton are actually below the average cost of production, meaning many are actually operating at a loss (USDA).
A limited shelf life
Agricultural commodities have a ‘use-by date’… they are perishable and the world needs and depends on new, fresh production each year. The World’s population is currently around 7.2 Billion and UN predictions could see this number swell to over 9.6 billion over the next 30 years leading up to 2050, meaning that global food production would need to increase by around 60% to meet this increase in demand. So, if a full scale La Nina scenario develops in the US and South America, we can expect to see a significant drop in the inventories of these perishable commodities which in turn would result in higher prices for them. Whilst Australia can certainly help to fill the gap for something like wheat, where we’d expect to see bumper yields in such conditions, and to an extent Sugar as well, other commodities such as Corn and Soybeans, citrus related products, coffee, cotton would be impacted significantly.
Back your view
One simple way for investors to get exposure to important agriculture commodities and to seek to benefit from this investment theme would be through our BetaShares Agriculture ETF – Currency Hedged (Synthetic) (ASX Code: QAG). QAG aims to track the S&P GSCI Agriculture Index which provides investors with exposure to the global prices (the US prices) of corn, wheat, soybeans and sugar. Due to practical issues associated with buying and storing these commodities, the Index aims to track the prices of futures contracts over the commodities, rather than their “spot” prices. In addition, QAG is currency hedged which means that the currency fluctuations between the AUD and USD should not affect returns. QAG is available to trade on the Australian Securities Exchange during the trading day.
The index which QAG aims to track is based on the price of futures contracts. Investing in commodity futures is not the same as investing in the “spot price” of a given commodity. As such, QAG does not aim to, and should not be expected to, provide the same return as the performance of the spot price of the underlying commodities. The performance of ETFs that are linked to commodity futures may be different to the spot price for the commodity itself.