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Increased volatility in ag markets due to La Niña?

 

BY SUSAN BLOWER
Indiana Correspondent

CHICAGO, Ill. — Ag markets may react with increased volatility in 2016 due to the current El Niño and its potential impact on future weather patterns, said the senior economist at CME Group, a leading derivatives marketplace.
This year’s El Niño is already one of the top four on record, explained Erik Norland, executive director and senior economist at CME Group. The Pacific Ocean has risen 2 degrees Celsius higher than normal, which is a significant change, and is still rising.
“Right now we say we think it’s really going to be one of the three strongest ones,” said Michel Jarraud, the secretary general of the World Meteorological Organization, who compared it with the 1997-98, 1982-83 and 1972-73 El Niño events. “It may be one of the two; that we don’t know yet. But definitely it’s already a very strong one.”
Based on past strong El Niños, it could turn into a powerful La Niña, as well. Historically, La Niña has brought higher-than-normal volatility in ag prices, Norland said. Accordingly, Norland told Farm World the ag sector should develop market strategies carefully with their investment counselor. “Everybody’s situation is different,” he added.
El Niño is a weather phenomena that arises in the central and eastern tropical Pacific Ocean with significantly higher surface water temperatures. Norland said that El Niño has the tendency to create unpredictable rainfall patterns that result in too little or too much rain.
El Niño will likely peak from November through January, but its effects will linger into the planting and growing seasons next year, Norland said. He added that investors will watch the planting season next March and April with interest.
The National Weather Service is predicting warmer and drier than normal weather patterns in the early spring for Indiana and most of the Midwest. Southern California is expected to be wetter than normal, a welcome change from the four-year drought. Weather experts caution that every El Niño is different, and predictions of its effects cannot be known for sure.
Drought next year is possible, which could result in a bullish corn market, Norland said. However, high global inventories of corn could mitigate price increases or even cause them to go down in the short term.
If temperatures fall quickly in June and July, Norland said it could indicate a move into La Niña. It’s too soon to evaluate the consequences of the current El Niño episode. Watching a full crop cycle is essential to understanding El Niño’s effects, he said.
“We are five months into El Niño, and we still have seven months left. In June we will be evaluating the impact of El Niño. We could be into La Niña in the second half to late next year,” Norland said.
Norland described the current market as “complacent,” but indicated that buyers of options may want to be more engaged.
“This is an intensive time to look at the market. If corn, wheat and soy become more volatile in the next few months, the cost of buying price protections will likely increase,” Norland said. “A lot of people in the ag sector – such as farmers selling or buying crops – often trade in options to generate protection in ag markets. It’s a good time to buy options if it’s already a part of their strategy.”
Other strong episodes of El Niño occurred in 1972-73 and 1997-98, resulting in a powerful La Niña. La Niña is a counter-cyclical weather anomaly that features cooler tropical Pacific Ocean temperatures. “Each of these episodes snapped back into strong La Niñas with high volatility. It depends on the strength. Exceptionally strong El Niños increase the potential for volatility. We could be in La Niña next year at this time,” Norland said.
 
Cautionary tales
Purdue University ag economist, Chris Hurt, urged caution last week as farmers react to market predictions. While Hurt said this is one of the strongest El Niños since the 1950s, he said weather pattern forecasts are based on historical tendencies and are not certain things.
“The National Weather Service is using the El Niño weather models through May. After May the National Weather Service says there’s an equal chance for any outcome because there’s not enough information,” Hurt said.
The market is buzzing about the possibility of a La Niña, however.
Higher temperatures and dry, even drought-like, weather accompany a La Niña, often with summers that are detrimental to ag production, Hurt said. These summers often start with an early, warm spring planting season.
“The timing of these events does matter. If La Niña is peaking in October 2016, it may not have any impact on the growing season,” Hurt said.
“I don’t want farmers holding grains with the false hope that the prices are going to go up. There is a stronger possibility (of future higher prices) than most years, but I don’t want producers betting millions of dollars or the whole farm on getting better prices,” Hurt added.
Indiana farmers may want to take advantage of high basis bids in the state as a result of a shortage of grain due to this year’s record rainfall. Hurt said local bids that are 20-25 cents higher per bushel than the national basis indicate buyers are aggressive for Indiana corn. He thinks many farmers may hold onto their grain, waiting for higher prices.
But Hurt said that higher basis could disappear as early as Dec. 10 as January sales typically increase, and those higher bids may not return until late February or March.
“As farmers look at basis bids, there are a couple strategies they can use. They can use a basis contract or sell cash grain and replace with a futures contract or call options,” Hurt said.
As Hurt measures market potential, he is not sure prices have bottomed out. He said two events could hurt prices. One is the question of South American yields. In the next 90 days, South America could be impacted negatively by El Niño – or not.
If those yields are average or above average, prices could move south, Hurt said.
The second event is the export market, which is depressed due to the strong U.S. dollar.
“We already have more corn and beans in the country than we can sell. If the South American crop is ok or better, we will have double the crop next March or April,” Hurt said.
However, Hurt said that farmers are accustomed to making tough decisions. He said diversification in markets can protect from too much risk.
“They have to make decisions all the time in uncertainty. They are used to that. They have to choose hybrids to plant without knowing what the weather will be. Some diversification in the market protects from risk,” Hurt said.
12/3/2015