How to trade extreme weather

Commodity strategists warn markets are underestimating the impact of climate change across asset classes as extreme heat grips Europe and meteorologists point to the risk of a strong El Niño this year.

The World Meteorological Organization expects a “strong El Niño event” in the tropical Pacific between July and September this year. El Niño is a naturally occurring climate pattern that increases sea surface temperatures in certain regions and is often associated with extreme weather conditions.

High temperatures, drought, heavy rains and other extreme weather events resulting from El Niño will upset bets on commodity assets, investment strategists say.

The warnings come as Europe struggles with a persistent heatwave this summer.

Parts of the UK have seen temperatures above 30 degrees Celsius (86F) for almost two weeks straight this month, while France has experienced three heatwaves this year and extreme weather forced the cancellation of some Bastille Day events last week. Meanwhile, South Korea issued its first “severe heatwave” warnings for Gyeongsan and Pohang earlier this month after adopting a new warning system in June.

Dan Leonard, Metdesk’s U.S. forecast director, said the upcoming “super El Niño” could “perhaps eclipse” major events in 1982, 1997 and 2015.

The impact on commodities will likely be uneven, he said.

Speaking to CNBC’s “Morning Call,” Leonard said that if the northern winter is warmer than normal, some markets could be hit hard and prices could rise, while others (like natural gas) could fall.

Agriculture is expected to face the greatest turmoil; Hotter and more unstable weather conditions threaten to reduce yields and push food prices even higher.

Societe Generale said agricultural commodity prices rose 7 percent this month, while soft goods such as cocoa, coffee and wheat rose 8 percent compared to last week.

U.S. Department of Agriculture data show food prices increased at an annual rate of 3.1% in May. A stronger El Niño could pose further upside risk, with food inflation potentially reaching double digits by 2027, according to a note from Man Group.

Albert Chu, Man Group’s natural resources portfolio manager, said crop yields in affected areas could fall by 5% to 12%, while staples such as rice could fall by 2% to 8% as prices rise due to hot conditions.

In a recent note from Man Group, Chu said treating the current El Niño event as an idiosyncratic event and chronically underpricing climate change in commodities is a “real risk” for investors.

“What if the current El Niño is just one point in a series of future events?” Chu asked. he asked.

Meanwhile, Bank of America analysts said Europe is warming faster than other continents and heat stress is increasingly structural rather than cyclical.

Coffee, cocoa, corn and wheat are among the crops most vulnerable to rising temperatures, analysts said in a note.

“These crops are extremely sensitive at key developmental stages such as flowering, pollination, grain and pod filling, where even short periods of extreme heat can lead to significant yield losses,” BofA analysts led by commodity strategist Daryna Kovalska said.

They said the value of corn was significantly lower, while sugar production by Brazil and Thailand would likely fall by 10% in 2026-27 due to the effects of El Niño.

Kovalska said the bank is optimistic about corn due to several weather risks, such as increasing heat stress in Europe, the El Niño threat affecting Brazil and warmer, drier conditions during the corn pollination period in the United States. BofA expects new corn crop prices to rise about $1 to $5.50 to $6.00 per bushel, from about $4.70 per bushel.

Extreme weather conditions affect metals, albeit in different ways, Chu said.

“Copper production is highly water-intensive, and heat or drought conditions can sharply restrict availability,” Chu wrote in a recent commentary from Man Group.

“Aluminium is energy-hungry in a different way; electricity accounts for 30-40% of production costs, and smelters rely on cheap, often hydrogen-generated energy. Refrigeration, food production and the growth of AI are poised to compete harder for the same scarce power and water resources.”