Category: Analysis

La Niña is coming. Hot on the heels of a record setting El Niño, another potentially strong weather phenomenon with very different characteristics could emerge later in 2016.

A consensus of longer-range computer models now show La Niña conditions emerging by around July, and should peak this winter at a moderate intensity. Strong El Niños are much more likely to be followed by a La Niña. The three strongest El Niños on record — in 1972, 1982 and 1997 — all transformed into La Niñas. In the video below the US National Oceanic and Atmospheric Administration explain what’s about to happen.

The timing of La Niña’s arrival is important to commodities markets as the weather phenomenon has vastly different effects on global climate than its warm counterpart, El Niño. For example, in agriculture markets, if La Niña moves in on the early end of the range by June or July, US summer crops could face complications with dry and hot weather, threatening corn and soybean crops. But dry regions of Australia, Southeast Asia, and Sub-Saharan Africa could receive ample rainfall prior to the peak of their next crop season. Such a scenario could lead to lower supplies of rubber, palm oil, coal and tin.

Source: FT

The last time La Niña arrived after a strong El Niño, in 1997 agricultural commodities showed little upward movement. Concerns about demand for all commodities after the Asian financial crisis limited any upside risk to prices. Fast forward 19 years and concerns about demand growth in many emerging economies are again not far from the surface while high agricultural stock levels should also act to limit the potential for higher prices.

La Niña could result in more hurricane activity in the US Gulf, potentially cutting oil and gas output from the region. Whereas the El Niño pattern warms waters, which correlates with more wind shear in the Atlantic basin, hindering the development of tropical cyclones. Conversely, the opposite is true with La Niña, where the cooler water in the Pacific leads to more favorable conditions aloft including less wind shear that leads to more development. According to Colorado State meteorologist Philip Klotzbach, over twice as many hurricanes have impacted the US during La Niña years as opposed to El Niño years.

Often forgotten in the shale hype oil output from the US Gulf is booming with supply expected to rise by 8% in 2016 to over 1.8 million b/d, offsetting declines elsewhere in the US. The last significant hit to oil output in the region came in 2008 from Hurricanes Gustav and Ike. With US Gulf output growing so fast any disruption could have a more significant impact on oil prices than we’ve seen for several years.

Related article: The changing of the seasons

Attention on the prospect of an escalation in the ‘currency war’ as economies seek to devalue their currencies hoping to gain a competitive advantage has tended to focus on the potential gains that exporters may reap. However, there is a flip side for economies devaluing their currencies and for manufacturers in particular. A decline in a currency simultaneously increases the cost of imports. If a manufacturer needs to import commodities and/or sub components its input costs may increase significantly if its currency devalues, irrespective of the underlying fundamentals of the commodity concerned.

The chart below from HSBC highlights those currencies most and least active in the so-called currency war. Japan has been one of the most active economy in managing its currency.

The yen fell towards its lowest level against the US Dollar for 33 months this week as Japan’s prime minister signaled that there would be no change to the country’s ultra loose monetary policy. The most recent Markit PMI data from Japanese manufacturers revealed that despite lower buying activity input prices rose in December, the first increase since April 2012.

For manufacturers outside Japan, further down the supply chain and which depend on the import of refined components, the decline in the yen may also lower costs. For example, the Hong Kong watch industry is the worlds largest importer of assembled moving parts, 57% of which and comprising 30% of total production costs, come from Japan.

In contrast to commodity price changes and their affect on input costs, exchange rate fluctuations are much more transparent to buyers further down the supply chain, buyers who may anticipate changes in a manufacturers input costs in their negotiations.