Bracing For La Niña's Impact On Commodities

By Erik Norland

Sea-surface temperatures have fallen to below normal levels along the central and east-central equatorial band of the Pacific Ocean, heralding what appears to be the onset of a La Niña (Figure 1). This would mark the ninth La Niña since 1959 (Figure 2). Previous episodes of La Niña coincided with exceptionally high levels of volatility in corn, soy and wheat prices.

Figure 1: Global sea surface temperature anomalies NOAA November 9, 2020)

Colder-than-normal waters along the central and east-central Pacific Ocean tend to change precipitation and wind patterns. During past La Niña incidents, there have been:

• Drier-than-normal conditions in places like the Southwestern and Southeastern United States, Peru and Chile.
• Wetter-than-normal weather in the Northern United States, Canada and Northern Brazil. 
• Stronger-than-average Atlantic hurricanes, and with more southerly storm tracks.
• Greater risk of excessive precipitation and flooding In Australia.
• A greater likelihood for typhoons hitting China. 

Figure 2: A major episode of La Niña is one in which temperatures fall 1⁰C or more below normal

Since 1959, most of the price gains in corn, soybeans, soy meal, soybean oil and wheat have occurred during the 12 periods of strong El Niño. El Niño is the opposite version of La Niña, with water temperatures in the equatorial Pacific Ocean being 1⁰C higher than average. El Niño has roughly the opposite effect on weather patterns as La Niña. Price direction has not been as strong during a La Niña as during an El Niño. During neutral periods, in which sea surface temperatures are within 1⁰C of their average levels, agricultural product prices have a slight tendency to fall (Figure 3).

Figure 3: Historically, most of the rise in crop prices has occurred during El Niño and La Niña.

While most price gains have occurred during periods of El Niño, past episodes of La Niña have been associated with exceptionally high levels of volatility in the prices of agricultural products. Moreover, the stronger the La Niña, typically the greater the degree of volatility. Corn volatility has averaged about 1/3 higher during periods of a La Niña than during an El Niño or neutral periods (Figure 4). Moreover, the greater the intensity of the La Niña (meaning the lower the sea surface temperature declines along the equatorial Pacific), the greater the historic volatility (Figure 5).

Figure 4: Historically, La Niña has heralded exceptionally high corn volatility

Figure 5: Stronger La Niña has often correlated to exceptionally high volatility in corn

Soy volatility has been even more extreme during periods of La Niña, more than 50% above El Niño periods and about one third higher than in neutral periods (Figure 6). For soybeans, too, the greater the intensity of the La Niña, typically the greater the degree of volatility in the year following the start of the La Niña (Figure 7).

Figure 6: Historically, soybean futures showed exceptionally high volatility during La Niña

Figure 7: Generally, the stronger the La Niña, the greater the potential for volatility

A La Niña’s historical impact on wheat is similar, if slightly milder. Wheat, too, has higher volatility in the year following the start of a La Niña (Figure 8), and also shows a tendency towards greater volatility during periods of exceptionally strong La Niña (Figure 9).

Figure 8: Wheat also shows somewhat higher volatility during La Niña historically

Figure 9 : Stronger La Niña has often been associated with higher wheat volatility than weaker ones

It is important to mention that five of the previous eight La Niña episodes occurred before 1995. Pre-1995, the US was the world’s dominant exporter of agricultural products. Since 1995, the world has diversified the sources of production, with South America pulling roughly equal to North America in corn and soybean exports while the Black Sea region has surpassed North America in terms wheat exports, while also exporting significant quantities of corn. As such, it is possible that the greater geographic distribution of crop exporting regions might buffer the impacts of El Niño and La Niña on price direction and volatility in the future. 

For their part, investors don’t appear to be overly concerned. Implied volatility on corn, soy and wheat futures are not trading at historically high levels (Figures 10 and 11).

Figure 10: Corn and wheat options are not currently pricing exceptionally high volatility

Figure 11: Soybean options implied volatility is slightly higher than average

Bottom Line:

• La Niña has coincided with historically elevated levels of volatility in the past
• Options prices are largely not pricing exceptional volatility going forward
• Generally, the more intense the La Niña, the greater the potential for elevated volatility

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