How more frequent, costly extreme weather events could shift commodity markets

The Cantillon effect, the Panama Canal, and Russia

While Pickering notes that grain prices began to rise in Q1 as he had initially predicted, the sudden onset of the US-Israeli war with Iran and the closure of the Strait of Hormuz shifted commodity investment capital to a focus on hydrocarbons. It’s an example, Pickering says, of the Cantillon effect: the idea that new money preferences certain assets over others. A focus on energy markets resulted in a wider neglecting of agricultural commodities. That was compounded by Russian grain hitting global markets as the world’s largest country sought agricultural revenues to finance its war with Ukraine.

Cracks are beginning to show in those grain markets, however, in part due to significant weather events. Low water levels in Gatun Lake in the centre of the Panama Canal have made shipping through that waterway more challenging and expensive, meaning key agricultural goods and agricultural inputs like fertilizers have been more constrained.

There are factors beyond weather, too, including the geopolitical tensions choking off the Strait of Hormuz. Gulf states are key fertilizer producers and much was made of constrained supply in February and March when the war began. That hasn’t shifted global agricultural prices as much as initially speculated, however, due to other sources of fertilizer and the timing of the war’s outbreak relative to planting and harvest seasons in the countries that rely on fertilizers from Gulf states. As time passes, however, some of those shortages will continue to show themselves.

Soft commodities and positioning for shortages

While grain prices have larger macro drivers pointing to price increases, Pickering notes that the simple fact that there is a large amount of global arable land for grain can keep those price swings moderated, especially when ‘swing producers’ like Russia end up on the scene. Agricultural commodities with more limited growing regions, especially regions more subject to extreme weather events like hurricanes and drought, can see greater price volatility. Coffee, cocoa, and sugar are all more susceptible to extreme weather, Pickering says. Coffee is the most recent example, with a big price movement in July. He notes that these commodities already come with high demand and tight supply, meaning that every little event that could impact production results in a big pop in their futures markets.

As a commodities manager, Pickering says that the approach at Auspice is to remain agnostic. Auspice operates long strategies looking for these upward movements in commodity prices and long-short strategies that can take opportunities from outlier moves, depending on the applicable investment mandate. He says that there is a “wheel of factors” that can impact commodities, with weather just being one of many forces. Managers like Auspice wait for the next factor to make itself known, looking at price and volatility, using a spike in price volatility as a signal to move into a position.