- 1999: Volume 8, No. 4 Weather Markets: Mother Nature's Role In Commodity Trading

Anyone who has lived through a hurricane, tornado, flood or other weather-related disaster can attest to the following statement: Weather is the most powerful force on earth. Very often, in just a matter of days (and sometimes only hours), climatic shifts causing droughts, floods, and freezes can drastically change the multi-year supply and demand outlook for dozens of different commodities-with surging or collapsing commodity prices often the result.

Make no mistake then: at times weather is the dominant factor in determining price action in some commodities. Some of the best bull markets ever seen were due solely to weather. Who can forget the coffee market of 1994, with the September contract more than doubling in value from late June through the middle of July due to two devastating freezes in Brazil? How about orange juice prices during the late December/ early January period of 1990, rising about 7500 points (over $10,000) due to freezing temperatures in the Florida citrus belt? The last time that the soybean market was above the $10 mark was in 1988, with those prices coming as a direct result of the Midwest drought during the summer of that year. When one thinks of weather markets, one normally associates them with higher prices, but weather can be just as responsible for major bear markets. In fact, one can blame the recent very low levels for commodity prices on the weather. Mother Nature has brought the nation's midsection (where the bulk of our corn, soybean and wheat crops are grown) fine weather over the last several growing seasons. This has resulted in record winter wheat and soybean crops as recently as last year, and historically low price levels for those two commodities. Even the historic lows seen in the oil markets late last winter can be blamed largely on weather, as a lack of cold temperatures (the winter of 1998/99 was one of the warmest ever seen) severely limited heating fuel demand.

Forewarned is Forearmed

There is seldom a time of the year when weather is not the dominant force behind prices of at least one major commodity. Thus, knowledge of the latest weather forecast almost ensures you of being on the right side of that market-assuming of course that the weather forecast you are using is correct. This uncertainty is what creates the extreme volatility normally associated with major weather markets. Weather is constantly changing around the world, and that in turns means that weather forecasts sometimes need to be changed or updated (and often on just a moment's notice). There have been cases where a market has been severely depressed in early trading, only to finish the day with sharp gains-all because of a change in the weather forecast.

All of this may sound a little complicated, but really it is not. One first needs to be aware of those times of the year when different commodity markets will be paying a lot of attention to the weather. Let's take a look at our list of major "weather market candidates," and those times of the year when they are particularly weather-sensitive.

Weather Market Candidates

WHEAT—March-June. Since wheat is grown around the world it can be affected by weather at almost anytime, but March through June is particularly important since that is when the big U.S. winter wheat crop comes out of dormancy and goes through the critical stages of development. Watch out for late season cold snaps that can hurt a crop after it has broken dormancy. Semi-arid areas of Texas, Oklahoma and Kansas can have problems with dry weather. Too much rain can be a problem for the wheat crop in the Ohio Valley, as it can lead to disease problems.

CORN/SOYBEANS/SOYBEAN OIL/SOYBEAN MEAL—June-August and January-February. The June through August time frame is a pretty obvious one; that is when the U.S. corn and soybean crops in the Midwest (Iowa, Illinois, and surrounding states) go through the critical stages of development. January through February has gained importance in recent years (particularly for soybeans) now that Brazil and Argentina have become major producers. It can be extremely difficult for these commodities to rally during the above-mentioned time frames if the market is not getting any support from the weather forecast.

COTTON—June-September. The growing season for the U.S. cotton crop is largely the same as for corn and soybeans. Cotton can withstand quite a bit of heat and dry weather without suffering a lot, but major droughts in primary growing areas of West Texas, the Gulf Coast, and the Southeast can impact the market in a big way. Beware of hurricanes moving into these areas during September; they have a devastating impact if the crop is in the open boll stage. Problems for major producers like China or India (particularly with regards to the Indian monsoon) can also be factors. Like corn and beans, cotton can have a tough time rallying in the summer months without support from the weather forecast.

NATURAL GAS—November-March. This is probably the most weather-sensitive commodity traded right now (at least of those that have a significant daily trading volume). The primary concern area is around the large cities of the Midwest and the Northeast. In the wintertime, if the market considers the forecast for these areas to be cold, prices go up; if not, prices go down. It's as simple as that. Major summer heat waves for the big cities of the eastern United States can impact trading as well, though not to the degree seen during the colder months of the year.

HEATING OIL—November-March. This commodity represented much more of a weather market earlier this decade, but importance of heating oil has been dwindling as heating units are converted away from heating oil. Still, major cold waves for the big cities of the Northeast and New England can catch the trade's attention rather quickly.

ORANGE JUICE—December-March. This is the time frame when Florida orange groves can be susceptible to freeze events. These do not happen often (the last time was December 1989) and thus the market is normally going lower during this period. When major freezes do occur, several days of limit-up moves often result.

COFFEE—June-August. Freezes in the coffee areas of Brazil occur even less frequently than do freezes in Florida. The coffee market often has a tough time going up during these months when there is not a freeze in Brazil, as that is also when the big Brazilian coffee harvest is flooding the market. However, when freezes occur-watch out!

COCOA/SUGAR—year-round. Major producers for cocoa are West Africa, Brazil, Malaysia and Indonesia. Europe, Australia, China and Brazil are among the world's leading sugar producers. The diversity of locations where these crops are grown makes weather a factor in these markets most of the time.

Figure 1

When and Where To Watch

Once you know what commodity to watch, the time of the year to look at, and the key part of the world to examine, it is simply a matter of determining whether the weather outlook is bullish or bearish-and taking positions accordingly. Leaning the wrong direction in a weather market can certainly have very serious repercussions. Expecting warm temperatures in Brazil during the summer of 1994 or expecting rain in the Midwest during the summer of 1988 would have obviously meant catastrophic losses. One needs to be fully aware of the risks involved when taking on positions in particularly volatile weather markets. Usage of options is highly recommended during such situations, especially for novice traders and those with limited amounts of available capital.

Craig Solberg grew up on a farm in northeast Iowa before enrolling in the meteorology program at Iowa State University in the fall of 1985. He has been employed by Freese-Notis Weather since receiving his Bachelor of Science degree in the spring of 1989. He became registered with the National Futures Association in July 1990 as a principal of Weather Trades (a commodity trading advisory firm). One of his main roles is contributing long range weather, crop, and commodity price forecasts for Trade Winds newsletter, and providing weather and commodity information for hotline and other daily services.

Weather Trades, Inc. provides subscribers with weather forecasts, commodity market information, and specific trading advice via Trade Winds daily service (twice-daily updates) and their monthly 12- to 16-page Trade Winds newsletter. Market opinions are based largely upon their interpretation of upcoming weather and its impact on commodity market action. Call them at 1-800-747-2471 for further information, or visit their website at http://www.weathertrades.com/.