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Price swings in commodity markets happen all the time. Supply chains, global demand, political maneuvering – there’s no shortage of factors that influence market dynamics here. But in recent years, there has been another undeniable force that I believe should be talked about: extreme weather.
Commodities like lumber, coffee, and natural gas have seen dramatic price fluctuations, often in response to natural phenomena, such as a sudden storm or drought thousands of miles away. As an example, recent data indicates that Arabica coffee prices hit $3.21 per pound in November 2024, reaching levels that haven’t been seen since 1977.
Although the general public might not pay much attention to such price swings, they still leave a serious impact on global trade and investment.
Why weather matters
The production of metals and industrials is largely shielded from climate-related shocks. A metallurgical plant isn’t going to stop because it’s raining outside – it would take an earthquake of tremendous proportions to get in the way of its operations.
On the other hand, many commodities are a lot more vulnerable to the whims of nature. A drought in Brazil or an unexpected frost in Vietnam can derail production overnight, decimating crops, halting offshore oil production, and so on.
Take natural gas, for another example: Cold weather increases demand for heating, but at the same time, severe frosts or winter storms can freeze pipelines (though not the natural gas itself), disrupting supply entirely. As a result, natural gas prices can surge in these situations.
Case studies: The lumber boom and the robusta crisis
Let’s rewind to 2020. The COVID-19 pandemic is probably the first thing to spring to mind, but there was also another storm brewing at the time – in the lumber market – and it took some time for people to notice it.
Wildfires in the western U.S., fueled by drought and rising temperatures, torched forests and lumber warehouses, disrupting supply chains faster than anyone was prepared for. At the same time, home construction was going through a surge because of all the lockdowns during this period, which meant that demand for lumber was through the roof.
The result? A market frenzy, with lumber prices skyrocketing by hundreds of percent in mere months. Volatility reached unprecedented levels as traders struggled to adjust to a perfect storm of limited supply and overwhelming demand.
Now, let’s fast-forward to 2023 for another example, when coffee enthusiasts experienced a market upheaval of their own. Vietnam’s Central Highlands (the world’s main production area of robusta coffee) faced a devastating drought. Crops were withering, rivers and water reservoirs dried up, and the rains so deeply desired by coffee farmers were nowhere to be seen.
Coffee plantations suffered, yields dropped sharply, and the impact on prices was brutal. When production forecasts were cut by as much as 20%, the price of robusta began to rise steadily, sending ripples through the entire supply chain. By the end of 2023, consumers were feeling the sting in their wallets as they looked at coffee shelves in their local grocery stores.
Managing risks
The incidents we covered above weren’t isolated. Climate models had predicted both the drought and the wildfires, and the signals were there for those willing to pay attention. But knowing the weather forecast isn’t enough.
Commodity prices are influenced by a mix of factors, from market sentiment to geopolitical events. And depending on the broader context, deviations in weather predictions can either set off a chain reaction or be ignored completely. It all depends on what specific market and commodity we are looking at.
So the question many might ask at this point is, how can companies and traders navigate this volatility? The answer has various layers to it.
Producers can hedge their risks through futures and options. Futures are straightforward enough – they lock in prices, allowing producers to protect themselves against sudden shocks. While this approach sacrifices the potential for additional gains if prices rise, it eliminates the risk of unexpected losses.
Options, on the other hand, act more like insurance, and while they’re a bit trickier to work with, they also offer greater flexibility. A producer might sell a call option or buy a put option to protect their downside, while a consumer could purchase a call option to cap their costs. These strategies allow market participants to adjust their positions based on forecasts and expected price movements.
Meanwhile, speculators trading commodity instruments have a unique set of advantages to work with. Unlike producers, they don’t have production volumes or established industrial operations anchoring their strategies. Although this lack of stability can be a disadvantage, it frees them to adopt a far more flexible approach because they’re not tied to a single commodity.
With the use of advanced forecasting tools and weather models, speculators can target various market opportunities. More importantly, they have the agility to rapidly adjust their strategies in response to changing forecasts. Being able to construct and deconstruct complex positions and dynamically shift their approaches as the market conditions change gives speculators an edge.
For more conservative portfolio managers, incorporating commodities can be appealing both as a hedge and a source of potential returns, if it is done with the right analytical approach. By combining knowledge of market fundamentals with quantitative modeling and weather data, investors can build more robust strategies.
A wake-up call
The events of the past few years have been a wake-up call for the commodity market, as multiple commodities have seen massive price run-ups due to weather-related disruptions.
Weather is no longer a side note, and ignoring it isn’t an option. If a trader deals with commodities but doesn’t monitor the climate conditions and underlying economics, they expose themselves to far greater risks. In today’s commodity markets, although there are tremendous opportunities, the odds of suffering colossal losses are just as high. Those who fail to adapt their strategies to account for weather factors will be left behind.
Alexey Afanassievskiy is executive director and the head of portfolio management at broker Mind Money.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
