Weathering El Niño's Financial Storm
WHY YOU SHOULD CARE
Financial shocks don’t always reverberate from countries’ poor economic policies.
By Simon Constable
Simonomics: A regular look at the global economy from a former staff columnist at The Wall Street Journal.
Kid weather is back and acting up with a force unlike what many investors are seeing out of Puerto Rico, Greece or even China. The “little kid” or “Christ child” — aka El Niño — could cool economic growth and stoke inflation around the globe in the months to come.
Yes, El Niño comes around every three to five years and lasts only about a year as ocean temperatures off the equatorial west coast of South America rise. But temperature increases of 4 to 6 degrees above normal can, and do, whip up potentially dangerous weather patterns, such as droughts and killer floods, which then hit homes, businesses and industries. The latest El Niño is slated by some observers to rival the one in 1997–98 as the biggest ever — one that killed an estimated 2,100 globally with a force roughly equivalent to 1 million Hiroshima bombs. It left $33 billion in property damages in its wake. “This could be a big one,” warns a recent report from Brown Brothers Harriman, a financial firm.
But predicting exactly what the weather will be is obviously tricky, and El Niño’s impact on the markets is usually quite specific. For instance, grain market speculators are currently watching the weather in Asia, where drought is a major concern. “We are already seeing dryness in India,” says Shawn Hackett, president of Hackett Financial Advisors. Cumulative rainfall between June (when the monsoon season began) and early July has swung from a 16 percent surplus to a 4 percent deficit in India. In short: “No monsoon, no rice,” says Milo Hamilton, president and senior economist of Firstgrain, which tracks rice industry news. In fact, Hamilton predicts rice buyers will become increasingly fearful, and he sees drought potential in Australia, Indonesia and Malaysia. If that continues, as the history of El Niños suggests it will, then rice crops could be smaller — which usually means higher prices for the grain.
There’s a likelihood of news-making rainstorms and floods. In that scenario, crops could be destroyed, sending food prices higher …
Rice is only part of the problem. Australia’s wheat crop outlook has already been lowered, Brown Brothers warns. Drought in the land Down Under, which is a big wheat exporter and where some observers expect the dry spell to continue, would drive prices higher on the world market. Already, wheat prices on the Chicago Mercantile Exchange have rallied around 8 percent since the beginning of June. Meantime, banks are carefully watching palm oil businesses in Indonesia and Malaysia, the world’s biggest producers of the commodity, which gets used in biofuel and for cooking. If palm oil harvests fall and prices rise, then the companies that buy palm oil may switch to soybean oil instead, warns Hackett. Indeed, in anticipation of extra demand, bean prices on the CME have rallied more than 10 percent since early June.
Of course, strange impacts from El Niño aren’t a new thing. Back in ’72 the combined effect of warmer water from an El Niño and overfishing depleted the stock of anchovies off South America. The little fish, known mainly as a love-it-or-hate-it pizza topping, has long been used as animal feed, says Don Coxe, chairman of Chicago-based Coxe Advisors, an investment advisory. He notes that the collapse in the anchovy harvest in the early 1970s led to U.S. agriculture switching more to soybean meal as a feedstock. USDA data shows a steep drop off in fishmeal imports to the U.S. in the 1972–73 season compared with the prior year, and there was also a doubling in soybean prices, which really never fully reversed.
Despite the forecasting problems, Joe Bastardi, chief meteorologist at Weatherbell Analytics, sees a big break coming for California’s drought this winter. But, he adds, there’s a likelihood of “news-making rainstorms and floods.” In that scenario, crops could be destroyed, sending food prices higher — California’s Central Valley is the primary source for some foods in the U.S. such as tomatoes and almonds. The state’s construction business could also be interrupted, and there may be massive losses in the insurance industry. That, of course, depends partly on who has flood insurance.
Needless to say, participants in financial markets will have a lot to digest this year — even if they don’t eat anchovies.