La Nina and Agricultural Commodity Prices in 2016

Harvesting Machine in field
••• Tim Phillips Photos/Getty Images

In the world of commodities, many different factors determine prices. When it comes to agriculture, one of the most important factors is the weather. Commodity prices have been moving lower since peaking in 2011. In 2012, due to a drought in the United States, the prices of the three major grain markets peaked. Soybeans and corn traded to all-time highs and wheat prices moved to a high level. While other commodity prices had already made highs the previous year, in 2012 these agricultural markets paid more attention to the weather than other factors that began to sour for raw material values.

In 2015, the cyclical bear market in commodities continued to send prices lower. Slowing economic conditions in China, economic weakness in Europe, a strong dollar, the prospects for rising U.S. interest rates and growing inventories sent prices of most staples lower. Meanwhile, ideal weather conditions for many crops sent agricultural commodities along for the ride to the downside. However, the development of the strongest El Nino since 1997 in 2015 caused the prices of some agricultural commodities to recover. Rice and sugar staged impressive rallies during the second half of the year.

El Nino occurs because of a large pool of warm water in the central and western part of the Pacific Ocean. Atmospheric conditions increased the temperature of the surface water. On the eastern side of the Pacific in New Zealand, Australia, the Philippines, Indonesia and as far east as India tend to experience drought conditions in El Nino years.

In North and South America, the opposite tends to occur. General climatic conditions are wetter and warmer. These conditions are facing the world late in 2015 and into early 2016. El Nino did not affect U.S. crops in 2015 as the yields resulted in the third straight year of bumper crops.

The opposite condition is a La Nina.

A shrinking of the large pool of warm water in the Pacific due to a strengthening of eastbound trade winds characterizes La Nina. Those winds carry colder surface water from east to west. The overall temperature of surface water decreases. On the western side of the Pacific, rainfall tends to increase in La Nina years and on the eastern side cooler temperatures tend to reduce rainfall. This can result in drought conditions.  While 2015 and the beginning of 2016 are El Nino years, the last La Nina year was 2011-2012. That was the year of the drought causing grain prices to explode higher. La Nina tends to occur every three to five years, therefore while La Nina does not necessarily follow El Nino, the chances for a development of this phenomenon will now rise with each year that passes.

The prices of soybeans, corn and wheat have fallen precipitously since 2012. However, at the same time demand continues to grow for these agricultural commodities due to demographics. Each day there are more people on planet earth and all need food for sustenance. The price of these grains remains well above levels seen in 2000, which tells us that the base price for these agricultural staples has risen with ​the population.

The natural extension of this phenomenon is that the next time crop output is below bumper status, prices will rise. In a drought year, the chances for new all-time highs will increase due to growing pressures from the demand side of the fundamental equation.

La Nina poses a threat for crop output, as the chances for drought in the United States will rise during La Nina years. The U.S. is the number one producer and exporter of corn and soybeans in the world and is a major wheat producer. With the price of these grain markets so much lower than in recent years and steadily increasing demand, it makes a great deal of sense to look out for signs of a La Nina. Sometimes the best opportunities in markets are contrarian in nature. With grains in a multi-year bear market, regardless of the action in other commodity markets the development of a La Nina could turn the prices of soybeans, corn, and wheat and cause a rally that few expect in the months and years ahead.