- Many forecasts suggest that stocks and bonds will yield lower-than-average returns in the near future — perhaps even over the next 10 years.
- But Shawn Hackett, president of Hackett Financial Advisors, says that agricultural commodities will outperform their averages due to a confluence of weather and climate cycles.
- Shawn joined Hari Krishnan for a conversation about how weather volatility and climate cycles affect the global economy and the commodity markets. Spoiler alert: We may be in for some wild temperature swings and even more “once-in-a-lifetime” weather events.
In light of projections that stocks and bonds will continue to yield disappointing returns — possibly for the next decade — we’re all looking for better investment opportunities.
Our guest, Hackett Financial Advisors President Shawn Hackett, is passionate about the minutiae (and big-picture trends) of “agricultural commodities, pricing, farmers and weather,” though not necessarily in that order. And he says that the agricultural sector is particularly promising right now. Unfortunately, that’s because we’re probably in for some weird weather.
Although the threat of climate change “seems to have excited the market,” Shawn hopes this discussion might help people “appreciate that there’s something unusual about this particular weather cycle, [because] a series of cycles exist in synchronicity today that have not come together for over 400 years.”
He thinks the upcoming cycle will be an “extreme event — above-normal weather volatility that we’ve seen in past periods of outperformance for agriculture.”
Shawn joined host Hari Krishnan on an episode of Top Traders Unplugged for a discussion about how changes in weather, weather volatility and climate cycles affect the economy — and what they can mean for savvy investors in the commodity market. Read on for a few highlights from their conversation.
Weather volatility, commodity ‘outperformance’
“Throughout history, there’s always been a give-and-take between stocks, bonds and commodities as a whole, including agriculture,” says Shawn. “We know that when commodity prices are doing well, as they did in the 2000s, the ’70s, and the ’30s, stock prices don’t tend to do well. Profit margins get squeezed. It’s very hard for companies to earn more money. As such, we get this period of outperformance for agriculture commodities.”
In agriculture, weather volatility tends to drive cycles: extreme droughts, floods and winters make it more difficult to produce food on a regular basis. The Dust Bowl of the 1930s is a classic example of a weather volatility event that led to a significant rise in agricultural prices.
He also cites the “global cooling scare” of the 1970s, although he may be referring to a now-debunked misrepresentation by conservative politicos of a lone Newsweek article from 1975.
“People forget that we were worried about freezing to death in the ’70s and now it’s global warming,” Shawn says. “It just seems like the pendulum swings back and forth.”
In the 2000s, energy was the hottest commodity, but today’s impending weather is “an order of magnitude off the charts from even prior extreme cycles,” he adds. That’s why he predicts agriculture will be the leader in the commodity space.
It’s important to note that rising temperatures alone are generally good for growing food.
“Throughout history, when the planet is in a warming phase, production goes up a lot,” Shawn explains. “Warm is good for crops. … There are endless examples of periods of warming that have led to a boom for yields in agriculture.”
Warmer temps allow farmers to use more acreage in areas that would be too cold under prior conditions, as well as offer longer growing cycles (more time to grow particular crops).
Warm weather, high yields; wild weather, crummy for crops
But when temperatures either flatten out or cool down, we see a significant reduction in yields because growing cycles become compressed. At the beginning of each season, frost comes later — and arrives earlier as each season ends. Plus, colder climates tend to have more violent weather due to a change in the upper airflow pattern of the northern and southern jet streams, driven by the activity of the sun.
Normally, a “zonal flow” creates “normal” weather. However, a Grand Solar Minimum (aka a period of lower sunspot activity) creates “a north and south undulating marinal jet stream” and “as hot meets cold, creates more violent reactions over time throughout the weather cycle.”
That volatility makes growing food difficult.
“We believe we’re entering a period in which weather volatility is on the rise, and we believe temperatures are actually going to start to decrease over time.”
Since 2019, when the Grand Solar Minimum began, global crop yields have flattened.
While warm weather is good for growing crops, wild swings are not. Shawn says weather volatility is the biggest contributor to yield declines. Crops can handle weather in a certain range, but extremes of heat, drought and rain cause most plants to go into shock.
Regimes and risks
In the finance world, we might call signals about weather “regime identifiers” or “regime indicators,” says Hari. “In the same way that maybe you take a handful of signals in the markets — the VIX, volatility levels, credit spreads, sovereign debt spreads and so on — and you say the markets are either calm or they’re volatile. Different strategies work in the two regimes.”
Hari proposes an analogy between El Niño/La Niña versus crop yields and the outcomes of risk-off versus risk-on regimes.
That works if we understand the big picture, says Shawn: “What’s the sun doing? What’s the upper airflow doing? What are the oceans doing? What are the longer-term trends?”
Those factors create a “base case” that generally leads to certain weather outcomes, like natural disasters.
“If you’re in the insurance business, this would be really important information,” Shawn says — that could impact how prices are set for customers, as well as protective measures for insurers themselves, who take on higher risk in the likelihood of extreme weather events.
“We’ve already seen quite a few of them,” he also notes, and some insurance companies “haven’t factored in that we have had five ‘one-in-100-year’ events in 10 years. The reality is that their actuarial tables are correct, but they don’t understand the cycle we’re in.”
Weather volatility and crop yield projections
Shawn argues that we will see a lot more of these once-a-century events in this cycle. The main driver of Earth’s overall temperature is the Atlantic Ocean. The Atlantic Multidecadal Oscillation (AMO, aka the temperature of the Atlantic) has been in a warm phase for the last 25 years. AMO phases are part of a larger, 40-year cycle driven by the sun and the moon relative to the Earth. That cycle is expected to turn negative within a few years, so the AMO will likely enter a cold phase around 2025.
That will lead to colder weather patterns overall, and unfortunately, “an environment with [colder temperatures and] weather volatility is much worse than a warming climate with weather volatility,” he says.
This eventuality could spell disaster for large swaths of the world’s farmland, and would undoubtedly push food prices up and juice the commodities market.
Having read some of Shawn’s reports, Hari notes that climate forecasts are akin to forecasts in the stock market world — there’s no one model that (accurately) predicts whether the S&P will go to up or down tomorrow. Many academics maintain that markets are unpredictable. But practitioners in the field have a handful of tricks — systems, models and so on — that they use to somewhat reliably make money over time.
In the commodities world, people use the most effective, reliable techniques they can to develop a unified view of what will probably happen in a given region.
Hari asks Shawn to name a few indicators that he thinks are most significant in predicting crop yields in various parts of the globe.
“Certainly El Niño and La Niña are very important — are we going to be in one of them or are we going to be in a neutral phase?” he replies. “Sometimes we’re in neither, by the way.”
The other factors are sunspot activity, the quasi-biennial oscillation cycle and the “base case” of Pacific and Atlantic temperatures, “because that’ll tell you where problems are going to be more likely to occur than not.”
The number of variables — macro-level cycles, seasonal trends and factors (like sunspots) that are literally out of this world — are dizzying. But based on the increasing frequency of natural disasters and erratic weather over the last few decades, Shawn’s commodities play could be a safer bet than the S&P.
Climate and solar events in alignment
Shawn isn’t a climatologist, but he “piggybacked on really smart people who came up with this stuff, and brought it all into a working model that people can utilize without having to read thousands and thousands [of] — and try and decipher — these very technical papers that oftentimes read like hieroglyphics instead of human English,” he says.
“To me that’s really the key: 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. Sometimes they’re in-cycle, which means they accentuate each other.”
And what really matters now is that the sea surface temperature cycle of the PDO (Pacific Decadal Oscillation, aka the fluctuation in temperature of the Pacific) and AMO, the Grand Solar Minimum, and the Gleissberg Cycle (a 70- to 100-year sunspot cycle) are all in synchronicity now, for the first time in over 400 years. This synchronicity could lead to an amplification of cycles that have a high correlation to dramatic increases in weather volatility.
When we talk about stocks and volatility, we know there are times in which “things come together that create the big move, the big event,” Shawn explains. “Those who follow stock cycles and are really good at it … just have a knack for understanding when a crash is coming, not because someone else said it, but because their cycles were lining up.”
Interested in commodities? Do your research
Just because a forecast seems promising (whether it’s Shawn’s or someone else’s), it “doesn’t mean you should enter any market at that exact moment in time,” Shawn says.
“We know that markets go up and they go down, and especially in commodities, there are expiration dates on contracts and on options, and so you really have to be careful of micromanaging timeframe against risk, against playing a particular trend.”
The flow of capital in and out of commodity markets, particularly agriculture markets, is a huge component to trading, Shawn adds. Every Friday at 3:30 p.m. EST, the Commodity Futures Trading Commission (CFTC) Commitment of Traders (COT) releases the positioning of speculators, commercials, small traders and more. “They even break it down into swap traders’ managed money,” he adds. “There’s a whole slew of different participants. They break down how much they are long, how much they are short, their net positions and open interest. Any person or entity with positions of a certain size has to report these to the CFTC by law.”
“I’ve tried to use this data quite a bit over the years, and it is useful, but one difficulty … is that some people defy classification,” Hari says. “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 an effective tool?”
In agriculture, it’s very effective, says Shawn, “because it’s clear who’s a commercial operator and who’s not a commercial operator. I don’t think a hedge fund is growing or storing corn.”
‘Know what you know’ — and what you don’t
Ocean temperatures and sunspots aren’t the only indicators of weather patterns and long-term climate trends. Disruptions to the earth’s axis and shifting of tectonic plates have a role as well. Plus, volcanic eruptions (like the January 2022 eruption of Hunga Tonga-Hunga Haʻapai, a submarine volcano in the Tongan archipelago) are inherently destabilizing to the weather — and to crop yields over time periods that can actually be part of an investment play.
Even though it happened nearly a year ago, the effects of the Tongan eruption in the southern Pacific ocean continue to stun scientists. Its massive explosion reached the mesosphere, almost 40 miles into the atmosphere.
“What’s interesting is every volcanic eruption we have seen in the last thousand years of this size has been an above-ground eruption that deposited sulfur dioxide in the stratosphere,” Shawn notes. Sulfur has a cooling effect on the Earth’s atmosphere because it blocks some of the sun’s rays — and “because land temperature falls faster than sea temperature, it tends to produce westerly winds, which produces El Niño,” he adds.
“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.”
The long-term effects of this event are up for debate. But many scientists believe that it will produce a short-term warming effect. It just might be enough to offset or distort other weather cycles. If we don’t experience El Niño soon — in the winter of 2023 — many places on Earth could experience a massive drought.
“It’s important to know what you know, and know what we don’t know,” says Shawn. “I don’t know exactly if this volcano is going to have an impact [on global climate] 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 why “it’s really important to get that forecast right over the next three to four months,” he says.
“Producers, end users, cattle ranchers, traders and investors, will have to do something entirely different if it’s going to be a 2023 event, versus 2024 or 2025.”It could be a global drought — or some unforeseen, unprecedented weather event with domino effects all over the planet. If so, some agricultural commodities will overperform and others may tank. But smart investors should watch for those big-picture forecasts and Friday afternoon commodities positions. Because if a recession comes (and by all accounts, it will), commodities are one of the best ways to diversify one’s portfolio in troubled times.
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.