Shawn Hackett - Global Macro Series - December 7th, 2022

[00:00:00] Shawn

They’re all in synchronicity. They’re all in cycle for the first time in over 400 years, which means this is an amplification of multi-cycles that have high correlation to dramatic increases in weather volatility. You talk about stocks and volatility; you know there’s times where things come together that create the big move, the big event, and those who follow stock cycles or know some of those cycles and are really good at it (like you said); they have a way of figuring these things out and just have a knack for understanding when a crash is coming, not because someone else said it, just because their cycles were lining up for it or vice versa.

[00:00:54] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:47] Niels

Welcome, welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting, as well as intellectually challenging, but also very important given where we are in the global economy and geopolitical cycle.

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global, macro driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations.

So please enjoy today’s episode hosted by Hari Krishnan.

[00:02:32] Hari

Thanks very much for the introduction, Niels. My guest today is Shawn Hackett, President of Hackett Financial Advisors in sunny Boca Raton, Florida, and agricultural commodity expert. It’s great to have you on, Shawn, and I’m sure we’ll have a great conversation today.

[00:02:54] Shawn

I’m really looking forward to it.

Agricultural commodities, pricing, farmers, and weather, are really things I am very passionate about and I’m really thankful to get this opportunity to do this with you. 

[00:03:07] Hari

Why don’t we start with a kind of a broad brush stroke. A lot of people have come to me and asked, “What are you going to do? How should I invest if stocks and bonds do nothing over the next 10 years? Where are opportunities going to arise?” Agriculture was a place that several people told me to look in. I think there is a pretty strong base case for investing or having some exposure to agriculture, but rather than my babbling on about it, maybe you can present that case for us. 

[00:03:41] Shawn

Throughout history, there’s always a give and take between stocks, bonds, and commodities as a whole, including agriculture. We know that when commodity prices are doing well, like they did in the 2000’s, like they did in the ‘70’s, like they did in the ‘30’s, stock prices don’t tend to do well.

Profit margins get squeezed. It’s very hard for companies to actually earn more money. As such, we get this period of outperformance for commodities and agriculture commodities. Specifically in agriculture, what tends to really drive the cycle is weather volatility. Meaning, increased extreme droughts, extreme floods, extreme winters, things that make it more difficult to produce food on a regular basis.

The Dust Bowl, the 1930s is a classic example of a weather volatility event that led to a big rise in agricultural prices. Back then there was the global cooling scare of the 1970’s. People forget, we were worried about freezing to death in the ‘70’s and now it’s global warming. It just seems like the pendulum swings back and forth. 

Now it’s a global warming scare that seems to have excited the market with weather volatility. I hope, by the time we’re done with our discussion, people might appreciate that there’s something unusual about this particular weather cycle in terms of that there’s a series of cycles that exist, in synchronicity today, that have not come together for over 400 years.

So this particular weather cycle, we think, is going to be a very extreme event above normal weather volatility that we’ve seen in past periods of outperformance for agriculture. As such, I think, in the commodity space as a whole, because of that, agriculture’s probably going to be the leader in that space.

Whereas in the two thousands, it wasn’t the leader. Energy was the leader in the 2000’s, I think agriculture could be the leader here, because weather is simply an order of magnitude off the charts from even prior extreme cycles. Like I said, you have to go back 400 years. That was the last time we saw something, in the 1600’s, quite like it.

[00:05:57] Hari

That brings me to the question. Can you say anything about the sensitivity of crop yields to, let’s say, temperature? In other words, if broadly, speaking, Brazil were one degree hotter on average next year, what impact would that have on corn yields and coffee yields and things like that? Or does one have to be a lot more granular than this? 

[00:06:22] Shawn

Throughout history, when the planet is in a warming phase, production goes up a lot. Warm is good for crops. It allows more acreage to be put into work in areas that would be too cold under prior conditions. It allows for longer growing cycles, meaning you have more time to grow a crop.

The more time you have, the more yield you can put on. There are endless examples of periods of warming that have led to a boom for yields in agriculture, it’s when temperatures either flatten out or cool down, that we actually get significant reduction in yields because of compression of the growing cycle, meaning you get a smaller window to grow crops, you get greater frost at the end of a crop – earlier frost at the end, later frost at the beginning, also creating damage. When you have a colder climate, you tend to have more violent weather volatility because what drives this cooler weather is actually a change in the upper airflow pattern of the northern and southern jet streams that’s driven by the activity of the sun.

Normally we have a zonal flow that tends to create normal weather, it comes in, it comes out, normal volatility. When we get into a grand solar cycle minimum, which is what they call these periods of lower sunspot activity, we get a north and south undulating jet stream – marinal jet stream, which creates this much more stagnant weather pattern and much greater weather volatility as hot meets cold and continues to create more violent reactions over time, throughout the weather cycle.

That’s really what drives very difficult times in growing food. If you look at the historical yields that we’ve seen during periods of warming, they go through the roof and when they have periods of cooling they really contract significantly. We believe we’re entering a period where weather volatility is on the rise, and we believe temperatures are actually going to start to decrease over time, making the environment much more challenging and difficult to grow food. 

Now, already, since 2019, when this Grand Solar Cycle Minimum began, yields are flattened down globally. Meaning we have not been able to grow yields in the last three to four years. That’s a big change from what we’ve seen for the last 450 years where we’ve just been able to grow food pretty regularly at will.

[00:09:06] Hari

Which is more important, temperature or volatility of temperature? In other words, you said warm is good for crops, but let’s say that the swings, within the growing season, become amplified. Is that a net good thing, or is it not? 

[00:09:19] Shawn

I would say that, overall, weather volatility is the biggest contributor to yield declines. Crops can handle weather when it’s more in a range, but if you throw extreme heat, or extreme drought, and then you put flooding rains on it 30 days later, the way nature operates… Think of the human body. I just went from 80 degrees, I was in Nebraska last week. It was 8 degrees with 30 mile hour winds. I had a very difficult time adjusting to that – very difficult time. Plants do the same thing. They just simply go into shock, quite frankly, when you have these wide variety of conditions that they don’t get enough time to react to.

[00:10:10] Hari

Now that brings us back to a point that you made about sunspots. Now my limited understanding is that sunspots are caused by magnetic flux within the sun or, basically, high fluctuations in the magnetic field in the sun that cause some energetic particles not to be emitted from the surface. So, you get these dark spots, and that’s somehow destabilizing to the weather on Earth. 

Can you say a little bit about that and what the significance of a large number of sunspots might be in terms of creating instability here on earth? 

[00:10:49] Shawn

The biggest thing with when you have the sun firing at a maximum level is it creates these big solar storms that tend to flood the atmosphere, and flood the earth’s surface.

Those kinds of big fluxes of solar wind, or solar energy, tend to cause all kinds of issues with tectonic plates, and earthquakes, and volcanoes. It blows out satellites and that sort of thing, and it creates (typically) hotter, warmer temperatures.

When you have what we have now, which is a lower sunspot activity, meaning that the magnetic fuel stream of the sun is actually weakened and we’re getting less solar activity, meaning that the solar radiation hitting the atmosphere is 50% of normal, that has the opposite effect, meaning that it cools the atmosphere of the earth and cold air sinks.

So, the atmosphere of the earth actually compresses, it shrinks. If you think of the jet stream as a rubber band around this sphere and you shrink the sphere, the rubber band instead of being nice and zonal will get crimped into this marinal jet stream – the north to south undulating airflow pattern.

When that happens, it allows the polar vortex of the north pole and the south pole to destabilize and weaken and it allows that cold arctic air to come further south or further north, depending on which hemisphere you’re talking about. It’s called a polar vortex, which you’ve heard a lot about in the last few years.

Sudden stratospheric warming events, which is where you get the sudden warming of the stratosphere. We had it last year that led to the late ending winter, which we forecasted by the way based upon our cycle work. That allowed for temperatures to be 30, 40 degrees below normal, all the way down into Texas because it drives that air down that normally wouldn’t be able to come down because of the change in the activity of the sun.

Because the magnetic field strength of the sun weakens, it allows these highly charged galactic cosmic rays to hit the atmosphere and hit the earth’s surface in much greater concentrations. 

We show charts to our customers that go over how those concentrations have been growing rapidly, and how those concentrations lead to increased cloud cover, increased storm potential, increased flooding activity. They also have a history of increasing large volcanic eruptions. 

We’ve talked about this for years, about how once you get into grand solar cycle amendment, you tend to get volcanic eruptions that are much larger. If you go back to 1400 to the present, there have been eight of these what we call Volcanic Explosivity Index eruptions, VEI six or higher. They go from 1 to 8. 

All but one have occurred during periods of lower solar activity. What’s amazing is we’ve just seen one this year, in February. The Tonga eruption was a VEI 6 volcanic eruption occurring exactly when we would expect to see something like that in a Grand Solar Cycle Minimum. It won’t be the last one we see. 

We will see at least two more, based upon the historical activity of past grand solar cycles. These volcanic eruptions have very, very significant impacts to global climate on a two to three year, even four year basis. Because these aerosols that get pumped into the stratosphere sit there and stay there for a while and really create a lot of havoc.

It’s very interesting how all these things are connected and worked together to create this weather volatility. I always hear people say, “Shawn, the fluctuations of the sun are so small it doesn’t have an impact.” That’s what the narrative is. It’s not the actual sun’s output that’s causing the weather volatility, it’s the changes in these cosmic rays, these upper airflow patterns, that actually creates the weather of volatility, not the actual energy itself. 

[00:15:20] Hari

Okay. Which brings me to a point that I need to understand as well, which is, as I understand it, the research about sunspots shows that the average temperature change, when there’s a high number of sunspots counted on the surface of the sun, is pretty small. On average sunspots don’t have a huge impact on global temperatures, but what you seem to be suggesting is that instability is induced by the presence (or the lack of presence) of sunspots, and the level of excitation of this ball of ionized gas (which I guess is what the sun is) is quite highly correlated with sunspots.

Over short horizons, if there are things like volcanoes, those inherently will be destabilizing to the weather and to crop yields over horizons that are actually investible. Is that kind of triangulating all the points you’ve made? 

[00:16:22] Shawn

It is, undoubtedly, that’s very well put. The other thing is that you have to think of what drives climate on earth? What drives climate on earth is not only the upper airflow pattern that we’ve just discussed a little bit about, it’s also the sea surface temperatures of the Pacific Ocean and the Atlantic Ocean. Are they hot? Are they cold? Is one hot and one cold? Is the other hot, the other one cold? Are they both cold? 

[00:16:49] Hari

Which leads us to La Niña and El Niño, I guess. That’s actually something you’ve written quite a bit about.

[00:16:56] Shawn

Yes. The La Niña/El Niño is a subset of this. If it’s okay, I would like to start on the bigger picture. 

There’s this global river, so think of the Gulf Stream off the east coast of the US. The Gulf Stream is part of this thermaline natural river flowing through the whole ocean. It equilibrates warm seawater in the center of the earth (in the equator), to the north.

We know that we have high tide, low tides every day. We know that the tides or the currents of the ocean are impacted from outer space. The sun, the position of the sun, against the position of the moon, relative to the earth, and the activity of the sun determine whether these currents are going faster than normal, normal, or slower than normal.

Now, because the Pacific is larger, it takes a little more doing to get that thing moving, and the Atlantic Ocean is smaller. They’re both around, what I would call, these 40 year cycles of where they will warm for 40 years (in sea surface temperatures), then they’ll cool for 40 years. But they’re off cycle.

They don’t go together. They go in an off phase cycle. That’s why you can have warm/warm, warm/cold, cold/cold, and what those two big bodies of water – what condition they’re in, what phase they’re in relative to each other, has a huge impact on temperatures of the earth. If the sea surface temperatures are warm, the air is warm. If the sea surface temperatures are cold, the air is cold. La Niña/El Niño is a manifestation of the sea surface temperatures of the central Pacific/central East Pacific. That’s a microcosm of those particular sea surface temperatures. 

[00:18:59] Hari

The significance of this Pacific, sort of the trade winds across the Southern Pacific, or the Equatorial Pacific, why are they so significant when you’re dealing with such a big complex system?

Do they just relate Asia and South America in terms of relative temperatures and the ability to have fisheries or grow crops and things? Why is that so significant? Why do people focus on it so much? 

[00:19:31] Shawn

If the Pacific is colder than normal (and it has been for the last 15 years by the way), you have much more frequent and longer ranging La Niñas, and you have much less frequent and shorter duration El Niños.

The La Niña pattern means hot, dry weather, typically in the growing season for South America, hot, dry weather, typically in the growing season for North America. It means a lot of rain in Asia, typically. Overall, because North and South America are so important to growing most of the big crops that are traded on the market and that people focus on, La Niña is a much more detrimental weather pattern than is El Niño. El Niño tends to produce big crops in North America and big crops in South America.

So, that’s why knowing what phase we’re in, in the Pacific, is so very, very important. It doesn’t mean you can’t get an El Niño, it just means the base case is more La Niña, less El Niño. Then if you go to a positive phase, where you have warmer Pacific Ocean on a regular basis, you have a lot more El Niños. The western half of the US has been experiencing a quasi semi drought for the last 15 years to the point where now we have water reserves getting dangerously low.

The number one question is, is this a permanent change or have we seen this before? My view is we’ve seen this before, and it’s actually getting close to the end of the cycle as the PDO is getting ready to flip to a positive phase as the long-term cycles would project.

[00:21:17] Hari

This is massively interesting to me, putting my finance hat on, because it’s a regime identifier, or a regime indicator. In the same way that maybe you take a handful of signals in the markets, the VIX, or volatility levels, credit spreads, sovereign debt spreads and so on and you say, either the markets are calm, or they’re volatile. Different strategies work in the two regimes. 

It seems like there’s a natural analogy between regime identification, let’s say in the El Niño/La Niña case and crop yields, in the same way that there is between the types of outcomes you get in risk-off versus risk-on regimes. It’s a really interesting analogy. Is that kind of the direction you’re pushing towards with this? 

[00:22:11] Shawn

It is, if we understand the base case, the big picture, what’s the sun doing? What’s the upper airflow doing? What are the oceans doing? What are the longer term trends? What’s the base case and what does that generally mean for natural disasters, for weather volatility? 

If you’re in the insurance business, this would be really, really important information on how you price your product and the kind of things that producers would want to have as protective measures depending on when they’re at higher risk for these extreme events to take place.

We’ve already seen quite a few of them, and all of a sudden the insurance companies seem that they haven’t factored in that we would have five100 year events in 10 years. The reality is that their actuarial tables are correct, but they don’t understand the cycle we’re in. We’re actually going to get a lot more of these “one in 100 year events” in this cycle because the cycle actually accounts for more of that. You know what I’m trying to say? 

So the way I look at the Pacific Ocean, the Pacific Ocean is really important [when it comes to] La Niña/El Niño and how that impacts heat, drought, rain, that sort of thing.

The overall temperature of the Earth is mainly driven by the Atlantic Ocean. If the Atlantic ocean is hot. You’re going to be in a warming phase. If the Atlantic Ocean is cold, you’re going to be in a cold phase. I show charts of historical periods over the last 180 years when the AMO, they call it the AMO (Atlantic Multidecadal Oscillation, which is the sea temperature of the Atlantic), when it’s cold, temperatures are blue all over the place. When it’s warm, they’re red all over the place. 

We’ve been in a warm AMO for the last 25 years. So we have had a very warm climate because the AMO is warm, as it all, naturally, was expected to be based upon the cycles. The 40 year cycle, that’s driven by the sun and the moon, relative to the earth, is expected to turn negative, meaning that the Atlantic Ocean is expected to move into its negative cold phase around 2025.

When that kicks in, then we shift not only to a more La Niña centric, continuing that la La Niña pattern, then we move into a much colder weather pattern, climate change. We already discussed how a cooling environment with weather volatility is much worse than a warming climate with weather volatility.

The last time we had a negative Pacific decadal oscillation and a negative Atlantic multidecadal oscillation was between 1965 and 1982. Anyone that was born in that time or lived through that time understands how cold it was. 

Growing degree days, in the United States, just as an example, on average was 134 days in the 1970s. It’s now (on average) 182 days. We have gained significant increases in growing days because of the warmer climate that we’ve had; because the Atlantic turned warm after we got through the mid 1980s, and led to a dramatic expansion. We were growing corn in North Dakota, for example. They wouldn’t have dreamed of growing corn in North Dakota in the 70’s. They would’ve a zero crop every year because it was too cold and the growing season was too short. 

All this ground in Canada and Northern Europe, for example, that’s been brought into production and growing big, big yields like it never used to, that’s all going to reverse, and that’s going to be a contributing factor to why these global yields are going to come under pressure.

Now, does it mean every year is bad? Does it mean you don’t have a good growing season? You will have some growing seasons that are good. It just means the base cases, you have a whole lot more trouble than not. We’ve been used to growing yields 1.5% to 2%, on average every year, every decade, every 20 years, every 30 years.

We’ve been just keeping ourselves just above the curve. Even if we still grow yields, but grow half as much, we have a big problem. How we handle that, we just have a big problem on our hands. The ‘just in time’ inventory ag system that we created, because we wanted to be more efficient at capital usage than having everything stockpiled for 12 to 18 months, and have it all spoil and all the costs that go associated with storing grain…

We went to this perfect system. What happens when we have these repeated issues? We don’t have that 12 months to 18 months of stockpiling. You don’t have any buffer stock, you have nowhere to go. My belief is we now have begun a stock rebuilding ag system again, getting back to where we were everybody wants more food on hand, than they did before, to guard against these risks that the pandemic, by the way, brought out in a way that nothing else could really express how vulnerable countries can be if they don’t have enough online and something goes wrong with a ‘just time’ inventory system.

[00:27:38] Hari

Perfect. 

I’d like to make a comment and then ask a question, which is first the comment is, one thing I really like about what you’re saying and doing having read some of your reports, is it’s a bit like in the stock market world there’s no one model that predicts whether the S&P’s going to go up or down tomorrow.

That led a lot of academics to go in the direction of saying that things are unpredictable, markets are efficient, blah, blah, blah. Fair enough, but the practitioners in the field have a handful of tricks, or a handful of systems, models, and so on, that they use to somewhat reliably make money over time. Of course, there’s a lot of noise. 

What you’re saying has an analogy, in the sense, that there are fluid flow equations that are hideously complex and non-linear that in theory, if solvable, would predict the weather going out over a reasonable horizon. None of these models are in working order or are perhaps not even solvable. So, really what you need is a handful of reliable techniques to try and come up with a unified view as to what you think’s going to happen in a given region. 

I think that’s fantastic. If I tried to push the envelope a bit further and say, if you had to pick four or five indicators that you think are most significant in predicting crop yields in various parts of the globe, what would they be and how would you mix them?

[00:29:11] Shawn

Certainly El Niño/La Niña are very important to get that right. Are we going to be in one of them or are we going to be in a neutral phase? Sometimes you’re in neither, by the way (you can have quite a bit of time where you’re in those time frames). Having a very clear understanding where we are with the Pacific Ocean and Atlantic Ocean, because that’ll tell you where problems are going to be more likely to occur than not.

There are other indicators like the quasi biennial oscillation (not to get too far afield), but these are very, very strong atmospheric winds that oscillate every 27 to 32 months, west to east, east to west. I always say this to everybody, “No two La Niñas are exactly the same.” They’re not exactly the same. No two El Niños are exactly the same. I see so many people project, “Oh, it’s a La Niña, that means everything is going to be just like the last one.” It’s not, this year is nothing like last year. We’re still in La Niña, because there are other variables that come into play, as you said, this fluid system interacts with each other, but one of them is the quasi biennial oscillation.

As an example, when the quasi biennial oscillation is going east to west, like it was last year, it tends to produce a more amplified jet stream. It tends to produce a weakening of the polar vortex. It tends to produce more volatile, cold, extreme, late ending winters when we get that La Niña combination with what they called a negative QBO.

That was one of the ways that we made our forecast last year. While we expected a very late ending winter, chaotic planting season (for planting in the Northern Hemisphere), and why we thought that grain prices had the possibility of spike trading into some kind of a high during that time frame, and we kind of nailed the forecast.

Now, this year we still have La Niña, although it looks like it’s starting to wane, but we have a positive quasi biennial oscillation. That means short winter, early spring, it means you could have some cold weather, but not the polar vortex frigid weather like we saw last year. You’re not going to likely get the destabilization of the polar vortex.

You’re not likely going to get the sudden forming event; probabilities are very, very low. That’s just one variable that, because it’s different this year from last year, changes everything about what weather we can expect and where some of the extremes may be. Last year, Brazil was immersed in a drought. This year they’re having fantastic rains, although Argentina’s still in a drought. 

These little nuances… I don’t spend my day worrying about, “Hey, next Tuesday morning, this is what the weather’s going to be.” That’s not that important. What’s important for my producers, for my farmers, for the market isn’t that, it’s what’s the big picture?

What is the big picture of weather trend that we are dealing with? If you get that right, if you get that overall picture right, you’re going to get the production right and the price direction correct. That’s what we try to focus on – these big trends, not are we going to have a snowstorm next Tuesday morning? I don’t know how to do that. I’m not trying to project that, but I do have a very good handle on that we’re going to have a short winter, which means if we have an early spring, with some good moisture, we could have an unbelievable planting season, which would create the potential for some record crops if we have moisture.

The big question mark that we might talk about is, are we going to get that El Niño to kick in in ‘23 and provide that moisture? Or are we not going to get that El Niño? Whether we get that, or not get that, has a lot to do with whether this drought continues further or whether we get a reprieve in 2023 or not.

[00:33:17] Hari

So three of the factories you would focus on would be the El Niño/La Niña regime. At this point, sunspot activity, or the number of sunspots, and also this quasi biennial oscillation cycle. 

[00:33:31] Shawn

And the base case of the Pacific and Atlantic. Yeah. 

[00:33:35] Hari

Perfect. 

Do the mega grain companies of the world, the ADMs, the Cargills, the Bunges, whomever, do they focus on this stuff? Do they have teams, legions of people doing this? Or are they missing the boat here? 

[00:35:50] Shawn

I would hope that I’m not the only one that understands these longer terms. It’s not like this is a secret. Thousands, and thousands, and thousands of papers have been written by some of the smartest people that have ever walked on this earth, that have done research.

I just took all this information and found what I believe to be the most reliable, highly correlated cycles, and just piggybacked on these really smart people that came up with those stuff, and brought it all into a working model that people can utilize without having to read thousands and thousands papers, and try and decipher these very technical papers that oftentimes read like hieroglyphics instead of human English. 

[00:34:31] Hari

Yeah, me too. Yeah, definitely. 

[00:34:34] Shawn

To me that’s really the key, is getting into what really matters, and just understanding when we’re in sync, and when we’re not in sync. Sometimes these cycles are off-cycle, which means they kind of cancel each other out; and sometimes they’re in cycle, which means they accentuate each other.

What I always try to really, really bring home to everyone, is how this sea surface temperature cycle of the PDO and AMO, the Grand Solar Cycle Minimum. This Gleissberg Cycle that we might talk about here in a little bit, what that is, they’re all in synchronicity. 

They’re all in synchronicity. They’re all in cycle for the first time in over 400 years, which means this is an amplification of multi-cycles that have high correlation to dramatic increases in weather volatility. You talk about stocks and volatility; you know there’s times where things come together that create the big move, the big event, and those who follow stock cycles or know some of those cycles and are really good at it (like you said); they have a way of figuring these things out and just have a knack for understanding when a crash is coming, not because someone else said it, just because their cycles were lining up for it or vice versa. 

[00:35:57] Hari

It’s a bit like the resonance that you’d see if you had a wooden bridge and multiple people were walking across at just the right distance apart.

Now we’ve talked a lot about the weather, but you do a heck of a lot of stuff other than that. I’d like to go into a little bit of that. One of them is I guess I’d call it positioning risk. You do look at the commitment of trader reports for the various commodity futures markets that you track, without presupposing anything, can you tell me when they come out, who’s listed in them, and how it all adds up? 

[00:36:37] Shawn

First of all, making a forecast, let’s just say that with my forecast last year, late in winter planting season, just because that forecast is made doesn’t mean you should enter any market at that exact moment in time.

We know that markets go up and they go down, and especially in commodities, there’s expiration dates on contracts, on options, and so you really, really have to be careful of micromanaging timeframe against risk, against playing a particular trend that you’re talking about.

We know that capital flowing in and out of commodity markets, AG markets, is a huge component to what a particular market is going to trade for. Every Friday at three 3:30 Eastern time, the CFTC, the commitment of traders, comes out and puts out positioning of speculators, positioning of commercials, positioning of small traders. They even break it down into swap traders, managed money. There’s a whole slew of different participants that they break down how much are they long, how much are they short, what’s their net positions, what’s the open interest? 

[00:37:50] Hari

Who sends this data? Is it the brokers? Do the prime brokers send the data to the CFTC?

[00:37:56] Shawn

It’s required that if you have positions that are of a certain size, you have to report them to the CFTC by law. 

[00:38:23] Hari

Okay. If I’m a hedge fund, I’m a spec commodities hedge fund, and I’m trading through some prime broker, the prime broker will have classified me as a speculator, and then they have to aggregate all the people like me, and they’re long and short positions, and then send them to the CFTC every week basically. That’s what you’re saying? 

[00:38:28] Shawn

That is correct. 

[00:38:29] Hari

Now, I’ve tried to use this data quite a bit over the years, and it is useful, but one difficulty that was pointed out to me, and that I found, is that some people kind of defy classification. Some entities aren’t really specs or hedges. They do both under the same umbrella. Is that a problem? Does the noise cancel out? Have you found it to be a very effective tool? 

[00:38:52] Shawn

In agriculture it’s a very effective tool because it’s very clear who’s a commercial operator and who’s not a commercial operator. I don’t think a hedge fund is growing corn, or storing corn, or doing those kinds of things.

[00:39:07] Hari

Not that I’ve seen, no. 

[00:39:09] Shawn

No, not that I’ve seen. 

What I always try to emphasize about, we’ve created what we call a smart money algorithm tool. We literally hand picked certain entities that had a high correlation to positioning at bottoms and tops. Then we normalized it by dividing by the open interest, because we know open interest over time has been growing. What was a record long position, 10 years ago, is now small. 

You have to aggregate it so that you can look at the seventies, eighties, nineties, and two thousands and actually say, “Is this a large position, long or short, relative to history?” Only to do this, you have to normalize it to the open interest.

Then, we are really a big fan of relative value. We love to look at corn relative to all commodities because we know that nothing lives in a vacuum. Everything is priced off of everything else. I view the relative value of a commodity like I view the price to book value of a stock, for example.

Is corn cheap relative to all of the commodities based upon its historical precedent? Now, just because it’s cheap doesn’t mean you go right out and buy corn. It just means it’s a market that is undervalued, and undervalued markets have a history of creating large moves when other conditions come to pass.

[00:40:31] Hari

Okay. Let me give you a setup case then. Let’s say that corn is trading cheap relative to history, but speculator longs are growing in the future’s contracts (we’re in whatever month is in the front or is being actively traded), is that a bull signal for you in isolation? So the “smart money” in heavy quotes is buying. 

[00:41:01] Shawn

The smart money, the speculators are typically short when you want to buy. The commercials are typically long when you want to buy. What we do is we invert the speculator. 

[00:41:18] Hari

Okay. That’s interesting. 

[00:41:21] Shawn

We take the shorts, but we invert it, so we add it to the commercials. There’s other entities as well that have either a pro or against it. Then we take that number and we divide it by the open interest.

Every market has a different DNA marker, meaning a different level that number has to get to before it is historically met that the market’s at the bottom. 

[00:41:44] Hari

Why would you fade the speculators? Why would you? I know that there are many other factors, but in isolation, if specs are short, why would that make you a bit more long biased than usual?

[00:41:57] Shawn

Speculators aren’t trend followers. They tend to be most emboldened at the low because a trend has been your friend for so long, and it tends to be most bullish at the top because a trend has been your friend for so long. Extremes in net long or net short positions, historically means a trend has tended to have gone as far as it typically goes before the powers that be look at everyone, on the one side of the boat, and say it’s time to revert. 

[00:42:26] Hari

So you’re saying the marginal buyer is gone – basically it’s tapped out if the market’s been trending up, and specs are fully loaded on the long side, and vice versa. 

[00:42:36] Shawn

Also, another way of looking at it is that a lot of times open interest reaches a peak at tops, and reaches a trough at bottoms, because that’s a measure of capital flowing in – maximum capital flows happen.  Just to give an example, when Russia invaded Ukraine, in February, that was the maximum capital flows into the commodity markets and agriculture – that was peak capital flows. They started to sell the month after, and we actually topped out in February. When you look at commodities overall, we actually topped out in February and made a secondary top in May.

The capitals have been flowing out ever since. Yet, when you watch the media, everyone says that’s the reason why we, now, should be buying commodities because Ukraine was invaded by Russia, and we’re all going to starve to death. Don’t forget, we already had a two year up trend going into that moment.

That’s the point where we had maximum participation by speculators, and on the flip side we had maximum bearish trading on commercials. That was the ideal period when one would be looking for the counter trade, the contrarian trade, the trade to go the other way because the cycles of capital flows are suggesting that while the long-term trend may well be higher, as I’m trying to persuade because of weather, within that long-term trend, you’re going to get some wild, ugly periods of decline.

If you’re in futures and options, and you’re not careful you may run out of money before you play the long-term trend. That’s why you have to be very cognizant of where are we in the capital flow cycle? Where are we in the relative value cycle, and where are we in the actual climate cycle? Is this a time for a breather in weather, which we get, or is this a time for it to kick up? 

All these are factors that go into when is the ideal time that one should be taking a look at a particular market for particular (in our case) climate degrees, versus taking a step back and saying, “Shawn’s idea is great, but right now the markets are not in the right phase to take advantage of it.”

[00:44:55] Hari

Perfect. 

Moving to the next topic, which I think is something you’ve discussed too, the currencies, obviously they have a big impact because at least say the Brazilian real, the Aussie dollar and so forth. The real is the poster child for this, but the strength of the currency relative to, say, the dollar obviously has a huge impact on crop prices.

How do you analyze that and do you only worry about it at extremes or is it always a factor in your forward looking analysis? 

[00:45:29] Shawn

Currency is most impactful when the currency is moving too fast for the market to react. We talked about how weather volatility moves so fast that the plant can’t react. When the dollar’s going straight up and no one knows what’s going on, and they’re watching pricing changing by the hour, by the day, and no one can react, it causes disjointed markets. It causes broken markets, it causes gaps in liquidity.

When we had this parabolic rise in the dollar this past year, when the Feds started to really put the pressure on rates and we really started to see that happen, that’s really what set the commodity markets off and really into a more protracted tailspin. Prior to that, the dollar had been moving up, but more gradually, more steadily, but the commodity markets were able to adjust and keep themselves fairly well elevated and then the spike trade came, and the markets then broke apart. Yes, overall level is important, but it’s much more important, the rate of change of the currency move.

For example, if the next year the dollar just stays between, let’s just say 105 and 110, and just goes back and forth and back and forth and remains at a higher level, the commodity markets can do very, very well. They’ll be able to adjust. Everyone will figure out, alright, the new rules of engagement, here it is. 

[00:47:05] Hari

So this is a bit like the inflation argument, right? Where if inflation popped to 8%, which it has, and then it just flatlined, the economy would adjust. Wages would adjust. Everything would adjust, and it wouldn’t be necessarily devastating. It’s just the uncertainty in the forward looking move that creates indecision.

[00:47:24] Shawn

Yeah, the oil shock in the 1970s, it just went through the roof and we couldn’t react. The stock market lost half its value. The economy went into a deep recession because you turned your head around and you’re like, “My gosh, I can’t afford anything.” It’s really the rate of change.

Of course, in the seventies, we got used to the higher price level. Everybody’s income’s caught up, everybody adjusted their lives and adjusted their consumption habits and everyone started figuring how we could produce more and we recalibrated. I really view currency in the idea of when it’s moving too fast for the market to actually take realistic, rational steps versus the actual level of set.

Now, don’t get me wrong, I’m not saying 105 versus 85. There is an overall more inflationary difference. In terms of the shorter difference, it’s really about the rate of change of the move, either up or down, and how that’s impacting the psychology of the market at that moment in time.

When you’re dealing with highly leveraged positions, which typically is what you’re dealing with in futures and commodities, it doesn’t take much of a move to get this capital out of sync with their risk tolerance. Then unwindings take place. Once unwindings take place, then there’s a snowball going down a mountain and then the situation has to run its course.

[00:48:48] Hari

I see. If the dollar spikes out of nowhere, that’s bearish for commodity prices globally? 

[00:48:51] Shawn

Correct, yeah. When the dollar spikes higher. Yeah, in dollar terms, sure. If you look at price of corn, maybe it just rises at a slower pace, but in the US dollar terms, yes, that is the case.

[00:49:07] Hari

So, high upside vol is bad for commodity prices in the dollar. High volatility in weather is actually bullish for commodity prices, at least at a very rough level, because it impacts yields. Volatility has variable effects depending on what’s driving things.

[00:49:32] Shawn

Think of it this way. If I’m a cattle producer and I’m expecting a good corn crop, I have three months of corn feed bought. Everything’s good. I’m not really too worried about it. Then all of a sudden a one in 100 year drought kicks in and we’re looking like production could be down by 30% or 40% and you’re watching prices taking off.

That cattle producer now says, “Oh my gosh, I need more coverage. I am in trouble. I can’t afford to feed.” Now he wants to buy a year’s worth of corn just like that, because of the volatility of weather to create the volatility in perceived production that caused the volatility in price that made him change his behavior dramatically.

Literally, it could happen just a couple of weeks ago from, “I’m not interested,” to, “I want to buy a year’s supply of corn.” Just like that. That kind of behavior, if every cattle rancher in the US and in Europe are making that same decision, the kind of demand spike you get from a weather spike is monumental in nature. That’s the old herd mentality that kicks in.

[00:50:36] Hari

No pun intended. 

[00:50:37] Shawn

Yeah, no pun intended. Of course. 

[00:50:40] Hari

Gotcha. 

I’m guessing that your sort of analysis has immense value to farmers who maybe panic if prices have gone down and want to dump all of their inventory to the market.

You can allow them to play the long game if, let’s say you think the weather is going to impact yields negatively. Is that the sort of thing where you feel you can add the greatest value, or is it more just alpha generation in trades? 

[00:51:06] Shawn

The long term planning is important. Let me give you a great example.

August, 2020, corn hit $3.18 on the spot price. Everybody was bearish. The average prognosticator was projecting $2.50, $2.75 corn, 3 billion bushel carry out, no hope, no future. A noose on the eighth floor was the best option for a farmer back then. 

[00:51:33] Hari

Doesn’t the average analyst have to take credit for the first third of every move?

[00:51:37] Shawn

So at that moment, at that key moment when everyone was telling the farmer you need to sell because these things are so bearish, we turned hyper constructive. Our weather work said that we were just about ready to enter a two year La Niña, based upon our cycles, that was going to create a significant increase in weather volatility.

We believed, when we looked at the coming out of the pandemic and the dislocation in the overall ‘just in time’ inventory trade, that the demand that would have to come back for most markets including agriculture, everyone was underestimating what that was going to look like.

Our recommendation to our cattle producers, our livestock producers, was to buy two years worth of cash feed at that time. That our farmers should cash sell only what they absolutely positively had to keep the farm going or their banker was forcing them to sell. Our recommendation was to store all the grain they possibly could in bins. If they didn’t have the bins, sell it and utilize paper to protect themselves to the upside.

You didn’t want to be someone that sold that first rally, the $3.80 corn and got rid of everything, because you were giving the farm away, no pun intended, again. That was a recommendation we made, documented in our reports on our interviews that we did at that time.

It was an unbelievable recommendation that saved our farmers who listened and followed our recommendation. It saved them huge anguish because so many producers did sell $3.80 corn and $4 corn, only to find out it was $7, $8, six months later, after eight years of pretty much losing money prior to that.

That’s, to me, how long term planning can make a very, very, very big difference to those on the farm and those in producing. Obviously, those listening who are investors in nature, or traders in nature, obviously could have done quite well, positioning for that kind of a change as well.

It was all predicated on smart money capital flows at that time. Having some of the strongest buy signals we have ever seen. Our weather work had a hyper, hyper, high probability of significant multi-year weather volatility coming up. We just had everything lined up for what we called a phase transition move.  Where you go from one price level to another. That isn’t something that most people are comfortable doing. Most people just rather go with the trend until the trend goes against them long enough to when they finally turn the corner at $5 corn and say, “Oh, it’s bullish now.”

We don’t think that really helps producers out and users out. We think the real way you help people out is to tell them, before a market really gets underway, that we’re about to do something and give them good reasons why. Also, by the way, give them an out, give them a risk parameter that if by chance, for some reason the weather cycles we discuss are delayed, or incorrect, make sure that they have an understanding of how they manage that risk in case there’s an imperfection in the forecast. 

[00:55:13] Hari

Perfect. 

Now, moving from the farmer to say the family office, or the institution, or whomever, who holds a 60/40 portfolio, stocks and bonds or whatever portfolio, a risk parity portfolio.

They’re thinking of throwing in the towel a bit on that paradigm based on recent performance. Not that they’ll get rid of all their stocks or their bonds, but they want to have something else to add. How should they play agriculture? Do you have any suggestions for them? 

[00:55:42] Shawn

Agricultural stocks do tend to outperform stocks at large, even during long periods of bear markets. The period from 1998 to 2012, the stock market went nowhere, but the agricultural stocks did extremely well. Now, they’ll get hit very hard if you have a crash, like 2008. It doesn’t mean they’re immune to the stock market gyrations, but the level of outperformance will be seen in the agricultural space, if I’m correct or we’re correct about the trends in agricultural prices being inflated or being in a more friendly environment for the next 10 or 15 years. Which means typically stocks being less favorable for that period of time. 

[00:56:26] Hari

Are demographics in your favor too, in the sense that if there is a burgeoning middle class, let’s say in China and India, they’re going to potentially eat more protein rich food, and that food will require greater crop supplies in order for the food to be generated? Are these kinds of trends that you think are significant as well for investors who wish to put more money in these sorts of stocks?

[00:56:57] Shawn

I don’t believe the long term trends really matter much, because the reason I will say that is that we had the same demographic trends from 2010 to 2020, and agriculture was just a horrendous place to be for that period of time. They went nowhere, stuck in an never-ending bear market, and we had those trends going on.

What drives the trends in commodities is, once again, a demand that comes out of nowhere, guns blazing, that the market can’t react to. The market’s fully aware of these longer term demographic trends. It’s adjusted to it. It knows it’s there. It’s incremental every year. As an example, like in the two thousands we had the ethanol, corn ethanol demand spike that came out of nowhere.

That really was one of the demand bases that took the market almost a decade to get its hands around before it did. China in 2000, also had a demand spike, out of nowhere, that the market wasn’t able to adjust to. In the 1970s, Japan, coming on to the economic ascension scene, had a huge demand out of nowhere, just running the market over. The market took a while to adjust to that demand. 

In the 1930s, post World War II, think of World War II as the whole world was shut down during the war, and then when the war was over, everybody reopened. Think of it as a pandemic. Everybody wanted to buy something all at the same time. We had a demand base that ran over the market for 12 years, and it took a while for the market to adjust to that rate of change of demand. It’s really these rates of changes of demand that come out of nowhere that drive these markets higher, not the systemic demographic trends that we all know that keep going. 

[00:58:46] Hari

I also thought this was simplistic, a simplistic argument. I was just curious because I have seen it presented and I don’t disagree, but where does the added return from agricultural stocks come from then, if it isn’t from some secular increase in global demand? 

[00:59:02] Shawn

The prices for everything go up. Your seed prices go up, if you’re a seed producer. 

[00:59:09] Hari

The input costs, yeah.

[00:59:12] Shawn

If you’re a fertilizer producer, your fertilizer prices go up – you’re making more. You’re able to get ahead of the inflation curve because your prices are going up faster than inflation, so your margins are improving.

Whereas in a bear market, it is exactly reversed. So, cash rents, people who own farmland and who rent it out to farmers who farm the ground, cash rents going through the roof. Your rate of return goes up because the prices that are now able to be paid by farmers who are now getting $8 for their corn versus $3 for their corn, allows the whole system to get liquified, to get larger.

It’s like blowing into a balloon and increasing the pie for everyone. That’s really what drives the returns in the industry is that ability. So, think about places like Cargill or Bunge or ADM, they have this global network. They’re able to take advantage of this arbitrage volatility that exists between countries that are inefficient, and price something here, and sell something there, and play the arbitrage because they have these feelers and they can make a killing when price volatility starts to go up. They have a huge advantage because of their ability to have this global visibility and taking advantage of these dislocations in price volatility, whereas, when prices are not false.

For example, five years ago corn volatility was at a 50 year low. There’s not a lot ADM can do to generate arbitrage profits when your corn price volatility is at 50 year lows – not a lot of opportunity. Now, when prices are moving up or down, 20 cents a week, there are all kinds of opportunities for them to take advantage of cash trading, which is what their bread and butter is.

That’s really where the outperformance comes from. I always say agricultural industry booms when everyone is busting, and agriculture is busting when everyone is booming. It’s on the other side of the economic moat. 

From 2010 to 2020, when the economy and the stock market were going strong, farmers were just struggling to try to keep it going. Now they’re having phenomenal times and everyone is struggling more and more from the typical dislocations that come from having an inflated price environment that we’re in now.

[01:01:35] Hari

I’m conscious we’ve taken some time, maybe not quite enough time that the weather has changed so that you have to make a change of recommendation. If there’s anything you’d like to conclude with, that would be fantastic. I’ve really enjoyed it. Let me start with that. 

[01:01:50] Shawn

I would like to leave with this concept, I get this question asked to me every time. “Shawn, how do you know these cycles are going to continue to repeat?”

I don’t know that they absolutely, positively are going to continue to repeat. I can tell you they’ve repeated for 300 years, or 800 years, but I don’t know. I can look for the sign posts that tell me if I’m on the right track, or not. That’s how you keep yourself either on the message or off the message.

I’m going to give you a great example. There’s a 180 year cycle of two year La Niña going to an El Niño. We’re in that cycle right now, meaning that every cycle that I follow that’s driven by the sun, by the way, the solar cycle of the sun, says that 2023 should be an El Niño year, which means improved production in North America, South America, big grain production, big increases in ending stocks, such forth and so on.

But we have this Tonga eruption that occurred in February. It was a Volcanic Explosivity Index of six. It reached the mesosphere, almost 40 miles in the atmosphere that hit the mesosphere. That’s how powerful it was. What’s interesting is every volcanic eruption we have seen, in the last thousand years, of this size, has been an above ground volcano eruption that deposited sulfur dioxide in the stratosphere.

Now aerosols, when they get to the stratosphere, they’ll stay there for three or four years before they dissipate. Sulfur dioxide blocks the sun from coming in, cools the weather. It also allows the heat from the earth’s surface to escape. It produces a very reliable cooling effect. Because land temperature falls faster than sea temperature, it tends to produce westerly winds, which produces El Niño. 

Those kinds of eruptions have tended to promote El Niño in the following year. This one was an underwater eruption. It didn’t deposit sulfur dioxide. It deposited unprecedented amounts of water vapor in the stratosphere. Water vapor also blocks the sun like sulfur dioxide, but it traps the heat.

All the papers that have been written, by people way, way smarter than me about this kind of stuff, believe that we literally doubled the concentration of water vapor in the stratosphere in two days, from normal. It’s extraordinary. They believe it is going to cause a short-term warming effect.

If we play this out, the speculation in the scientific community is, that means that if the land temperatures are going to warm faster than the sea temperatures. It might delay the onset of El Niño. It might push off this 180 year cycle, that I just mentioned to you, that has been reliable every single time. It has never failed. It’s possible that this extraordinary eruption, that occurred in February, might alter or distort the cycle, meaning delay the onset of El Niño. 

If we delay the onset of El Niño, and we stay into a neutral to La Niña phase in 2023, then the one in one to a hundred year, 90 year Gleissberg cycle drought that has verified, by the way, for the last 10 centuries, this 90 year cycle has verified the one in one to 100 drought in the United States. That means pretty much everybody has drought, pretty much. It means that it would happen in 2023, instead of happening in 2024, 2025. I don’t know, and neither do the NASA scientists or anyone else that’s written papers on this, because there is no data point that tells us exactly what this is going to do.

Once we’re through this, we’ll have a very good understanding of what a water vapor volcano will do in a stratosphere. What I’m going to be doing and what I’ve been telling all my customers, what I’m going to be doing is saying, “Look, I know what’s supposed to happen if the 100 year cycle is in place. I know where we need to be over the next three months.”

If we keep tracking down that path, I’m going with the 180 year cycle is going to continue, El Niño is coming, all is well with the world. If we start falling away from that 180 cycle, the cycle is diverting from what it always has in the past, and it’s showing we’re not going to get the El Niño in 2023. You only need neutral.

You cannot have a drought with El Niño, but you can be neutral or neutral La Niña to have a drought. Then I’m going to be pivoting towards, instead of the drought being 2024, 2025, which has been my forecast, I’m going to pivot to 2023 is actually going to be the year for this instead of 2024, 2025. Because this volcanic eruption, which clearly has the potential to disrupt cyclical weather, may have an impact of delaying this very reliable cycle. 

[01:07:20] Hari

So the trade would be long front year grains, short back year, something like that? 

[01:07:27] Shawn

Something like that, yeah. 

[01:07:28] Hari

Very interesting. 

[01:07:30] Shawn

It’s important to know what you know, and know what we don’t know. I don’t know exactly if this volcano is going to have that impact or not, but enough work has been done and I’ve read enough papers to know that there’s a possibility that it could. 

That’s really important to get that forecast right over the next three months to four months. Producers, end users, cattle ranchers, traders, investors, will have to do something entirely different if it’s going to be a 2023 event, versus 2024, 2025.

That’s an example of monitoring the cyclical work, monitoring these correlations and making sure nothing is happening that’s diverting from normalcy. 

[01:08:21] Hari

Perfect. 

It’s been a pleasure. Thanks Shawn. I hope we can do it again. With that I will hand it back to Niels. 

[01:08:31] Niels

Thank you so much, Hari and Shawn for a conversation that I think will blow a lot of people’s minds when they hear this.

If you don’t think commodities are important and cycles are critical to understand and follow after this period, then we just have to try harder. Of course, some of the key takeaways are Shawn’s view on the sunspot cycle and how he and our previous guest, Simon Hunt, expect it to peak soon and lead to cooler temperatures, which in turn will have a negative impact on how much food we can grow around the world.

The importance of the ocean temperatures was also fascinating to learn about and news to me, frankly. Of course, the coming period of weather volatility, just like we are seeing increased volatility in financial markets, should make investors more interested in strategies like trend following that focuses on including commodities in their portfolios.

Whether or not we’re going back to a cold period like 1965 to 1982, I don’t know, but I do know that we need to get Shawn back next year for a follow up conversation. 

Make sure you go and follow Shawn’s and Hari’s work, because as you can tell from today’s conversation, there are many exciting facets to learn from people who have been in the trenches for many years, and we really look forward to exploring more of these conversations as our series continues. From Hari and me, thanks so much for listening, and we look forward to being back with you on the next episode. In the meantime, take care of yourself and take care of each other. 

[01:10:00] Ending

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