Raising the Temperature on Agricultural Commodities

The agricultural commodity market—which includes grains, livestock, and dairy consumed daily—is highly sensitive to variations in weather and climate.

Rising global temperatures, as well as the increasing frequency of extreme weather phenomena due to climate change, have driven up food prices by as much as 20% over recent decades and created erratic trends in agricultural production.

Increase in Volatility

Climate change exacerbates inconsistencies in agricultural conditions—particularly in terms of temperature and precipitation—as well as the frequency of severe weather.

For instance, 8 out of the 10 most expensive hurricanes in American history happened just within the past decade. The problems associated with climate change are further compounded by the global nature of today’s agricultural commodity markets. A deficit or supply in one market can impact producers and consumers worldwide.

This volatility in weather patterns thus creates challenges for investors who rely on traditional financial models and discretionary analysis of supply and demand for agricultural commodities—which ultimately leads to greater uncertainty in the markets.

Shifts in Agricultural Trade and Production Patterns

The UN issued a “State of the Agricultural Commodity Markets 2018” report which identified future winners and losers in agricultural commodities due to climate change (with 2050 as an end-point).

The report stated that as global temperatures rise, agricultural production regions of higher latitude and temperate climates, such as Russia and Canada, will benefit the most from rising temperatures as well as longer growing seasons.

In fact, Finland is anticipated to be warm enough to produce cereal, while China is expected to be able to produce a wider variety of commodities and maintain its position as a leading exporter. For investors, food commodities traded at a greater scale can serve as new investment opportunities.

Meanwhile, countries in tropical regions will likely experience losses in agricultural production. India’s farming yields are expected to fall by 2.6%. Producers in these regions could potentially be forced to relocate to regions with more viable climates.

Those in the Northern Hemisphere will be pushed north, while those in the Southern Hemisphere will be pushed further south. Therefore, investors will have to factor shifting crop production, changing agricultural practices, and volatile trade patterns into their risk assessments for commodity price spikes.

The Struggle to Meet Global Demand

Financial advisers should also be cognizant of how climate change heightens the imbalance between demand and supply of agricultural commodities.

According to a UN report on climate change, global warming could reduce agricultural production by as much as 2% each decade for the rest of this century.

On the other hand, as our global population continues to expand and as people in developing nations acquire the wealth to consume richer diets, demand is expected to rise as much as 14% every decade.

Therefore, if the UN is correct about the widening disparity between demand and supply for agricultural commodities, their prices will rise accordingly in the long term.

Furthermore, since large surpluses are rare for most agricultural products (while demand steadily increases), just one dip in supply due to a storm or wildfire can dramatically impact the market.

For instance, in 2006, Australia’s wheat production was severely undercut by a severe drought. Wheat supplies were already tight relative to demand, so the shortage created by the drought thus caused a sharp rise in global wheat prices.

Climate change will also make it more challenging to raise livestock and catch seafood using the same ways and at the same capacity that we are accustomed to.

The New York Times reported that in 2012, the U.S.’s cattle herd shrunk by 2% to less than 90 million head, which resulted in unprecedentedly high prices for cattle commodities.

Additionally, warmer water temperatures will likely disrupt both ocean ecosystems and the markets of seafood commodities by causing the habitats of fish and shellfish to shift.

Next Steps for Investors

The implications of climate drivers of agricultural price volatility thus create both opportunities and challenges for investors. Financial advisers should closely monitor the impact of climate change on commodity markets as well as the effects of such changes on their clients’ portfolios.

In order to use commodities to hedge against risk in the equity portion of portfolios, advisers can seek ways to capitalize on the long-term market effects that result from the changes outlined above.

One of the main ways to gain exposure to agricultural commodities while minimizing risk is through managed futures—which are negatively-correlated to the performance pf other assets.

Furthermore, investing in cropland located in regions with enhanced production capabilities due to rising temperatures allows advisers to make positive use of the negative reality of climate change.

By Yani Li