The MJO Is Gaining Strength: What This Means For Commodities

by: James Roemer

The MJO is known to modulate tropical activity in the Indian Ocean, Pacific and Gulf of Mexico and can have huge implications for crops in South America, West African cocoa and even the hurricane season in the U.S. In addition, when it is strong it can have major temperature ramifications for U.S. energy regions (heating oil, natural gas, etc.).

The MJO (Madden-Julian Oscillation) is not a stagnant weather pattern, such as El Nino or La Nina, but is an occasional eastward progression of a strong wave, initially observed in the Indian and Pacific Oceans. When it is strongest (the farther away from the center of the circle below), then this could enhance or disrupt global weather patterns. Right now, we will be heading towards a strong phase 8 MJO for the next couple weeks.


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La Nina or Not and Cold European/Eastern Weather Helping Heating oil

There is much debate about whether or not La Nina may form this spring/summer, because if she does, this could have grave ramifications for the U.S. wheat crop, which is already in lousy condition from Texas to Nebraska. Also, corn and soybean traders will be following closely updated forecasts, not only for South American the next 4-5 weeks but for the Midwest. The strong MJO usually does not portend a La Nina event, even though ocean temperatures have been cooling over the Equatorial Pacific. Hence, for this particular spring and summer, there are very mixed signals as to whether or not the U.S. drought will continue.

One of the biggest impacts the MJO is having, combined with incredible warming aloft over the arctic circle, is the cold U.S. weather hat we began telling clients about a couple weeks ago. When the MJO is in phase 8 (travels from the Indian Ocean all the way to the western Atlantic), the result is usually for colder weather for at least the eastern United States. Brutal cold and snows in Europe this week and cold weather in the eastern U.S., has finally resulted in a modest rally in heating oil futures versus crude oil. Look for another major cold shot for the Midwest and East the first week of February with possibly some much needed snows for ski resorts from New York to Maine.

Strong demand for crude oil and some talk of OPEC production cuts have helped crude oil futures the last couple months. However, the recent eastern and European cold has helped heating oil gain versus crude since late last week. With some easing of the severe cold in Europe next week, and warming this weekend at places like New York, Boston, etc., its hard to say how much more upside in this spread might occur. Nevertheless, my forecast for a cold February in least the eastern United States could result in at least one more bullish reaction in heating oil, the first week of February.

With respect to natural gas prices, last week's big warmth in the eastern U.S. (8-14 degrees above normal) and the reality of still a big surplus of supplies is keeping this market at bay. Prices have rallied 10% the last 2 weeks due to recently friendly EIA numbers and the present cold weather. I still view natural gas price action as a "trading affair" with a very low probability that prices will come anywhere close to $3.00 given cold February weather and probably a 65% chance we will trade in the upper range of this winter's price channeling, possibly approaching $3.80-$4.00 later.

More on the MJO and Other Commodities

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With the MJO in phase 8 the next couple weeks, weather conditions will remain mostly favorable for West African cocoa regions and one key reason prices have fallen some 15% since September. World coffee areas will be mostly beneficial and a return of big rains to northern Brazil has helped to pressure coffee. Farmers are still sitting on a lot of coffee from last year and after a brief rally into the $1.55/lb range last week, prices have since faltered again.

The combination of Pre-El Nino conditions last fall and the MJO not in a favorable position for Australian rainfall, has helped to hurt the New South Wales cotton crop. Rains will return to Australia due to the MJO moving quickly, but it may be too late to help the Aussie cotton crop much. In addition, sub-par growing conditions have recently returned to parts of northern Argentina and southern Brazil cotton. However, the real bullish impetus to the cotton market -- ETF (BAL) has rallied some 10% the last few weeks), is due to our earlier comments that world acreage might decrease 10% or more in 2013, due to high world grain prices. Until the drought in Texas breaks and until traders feel comfortable with what world acreage and weather conditions will be this spring and summer, cotton futures still have more room to the upside, in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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