Commodity markets wary of false alarm as El Nino blows back

After a five-year absence, El Nino is back. The last time the weather event emerged in 2009-10, droughts damaged crops in Southeast Asia and Australia sending agricultural commodity prices soaring.

First observed in the 19th century by Peruvian fishermen, the recurring weather phenomenon is known to affect Australasia as well South America. Its climactic effects can reach as far as west Africa.

This week's announcement by the Australian Bureau of Meteorology (BOM) of a "moderate to strong" El Nino emerging this year may lead to farmers and commodity investors adjusting their hedging and positions.

"Potential shocks to commodities markets [like El Nino] tend to shape the risk profiles of market participants," says Mark Keenan, head of commodity research for Asia at Societe Generale.

However, some investors may be hesitant to react, after the false alarm in 2014, when weather forecasters raised the alarm of a potential development of El Nino, say commodity brokers and traders.

In March last year, weather experts pointed to the rapid warming of the tropical Pacific, the key signal for El Nino, only for some of the conditions to peter out.

With sea temperatures rising again since the end of 2014, the US federal National Oceanic and Atmospheric Administration announced that El Nino had developed, in February this year.

Some commodity market participants are suffering from "'the boy who cried wolf' effect", says Jonathan Parkman, co-head of agriculture at commodities brokers Marex Spectron. "The threat of El Nino has been in the market for a year and as a result, people have tended to take it less seriously," he adds.

They may be forced to adjust their portfolios if, as climate experts predict, the tropical Pacific Ocean will continue to warm in the next few months and continue through to the end of this year. The weather phenomenon can last for as little as six months or as long as two years, says Andrew Watkins, manager of climate change prediction services at Australia's BOM.

Farmers in Australia are among those who are likely to feel the most pain. The country has suffered significantly lower rainfall for the 2012-13 season and below average precipitation in 2013-14.

The country's wheat crop has already taken a hit from dry weather, and could see further drought damage. Incitec Pivot, the Australian fertiliser group, this week cautioned that "Australian growing conditions at the moment look quite challenging" for the wheat crop.

The country's dairy and beef industry could also be affected by the potential for reduced grass fodder production through the winter, says Tracey Allen, analyst at Rabobank in London. Sugar cane in the northern part of the country will also be impacted.

Dryness in Southeast Asia will could depress harvest levels of crops including rice and sugar in Thailand, robusta coffee in Vietnam, and will add stress to rubber and palm oil trees in Indonesia and Malaysia.

El Nino has also been linked to a weaker Indian monsoon. The annual monsoon is critical for the country's agriculture, but lower than average rainfall could affect crops including rice, wheat, cotton, and sugar.

Indian farmers are large buyers of gold, and analysts at UBS last year raised concerns that a potential weak monsoon could hit purchases of the precious metal.

El Nino has tended to impact cocoa production in west Africa. During periods of the weather event, weather in the region has tended to be dry, leading to a fall in output.

Meanwhile, Peru's anchovy catch is almost always affected by the weather event, says David Streit at weather consultancy Commodity Weather Group.

The country's fishermen have already feeling the impact of warming waters, as a sharp drop in fish stocks late last year prompted the country's fishing authorities to close its fishing season for anchovies - the main ingredient for fishmeal.

The price of fishmeal hit a record high last November, and although stocks off the Peruvian coast have since recovered, the country's fishing industry remains on high alert.

Elsewhere in Latin America, El Nino tends to bring wetness to Brazil, and rains could hamper sugar cane harvesting, lowering the level of sucrose, or the sugar levels in the plants.

It is not just agriculture that will be impacted.

In the past, droughts in Indonesia, a leading nickel and copper producer, have led to output declines as hydroelectric power facilities were affected as were the water levels of inland waterways used for ore transportation. In Peru, heavy rains flooded in zinc mines, triggered price spikes.

Back at the Australian weather bureau, Mr Watkins is still "fairly cautious" about its latest forecast.

What makes it doubly difficult for weather forecasters and commodity investors is that the effects of El Nino on the actual weather in different parts of the world are as hard to predict as the strength of the weather phenomenon itself.

Says Mr Watkins: "No two El Ninos are the same."

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