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PRUDENTIAL
SECURITIES, INC.
One New York Plaza,
New York, New York
(October 27, 1997) CORN:
DEBUNKING THE EL NINO PROPHETS WHO PREDICT U.S. DROUGHT–El
Nino continues to be a hot topic of conversation, and its potential
impact on corn and wheat prices for the upcoming year was widely
discussed among analysts at last week's Industry Outlook conference
in Chicago. Some analysts believe it will be a swing factor to
price forecasts while others look for El Nino to be the main
driving force for the upcoming U.S. 1998/99 crops. We have written
extensively about El Nino over the last several months and have
concluded that there is not much correlation between an El Nino and
a drought in the U.S. Corn Belt the following year. Of course, it
does not mean that there will not be a drought, just that if there
is the drought may not necessarily be correlated with El Nino
events. Nonetheless, there is a school of thought that believes
there is a strong correlation. Considering that (1) this El Nino is
the strongest on record (2) the 1997/98 corn balance sheet is
relatively tight (3) and continued wide press coverage of the
weather phenomenon, we believe it is time to explain (again) what
all the fuss is about.
An El Nino event, as defined by the
National Center for Environmental Prediction (NCEP), occurs
whenever the five-month running average of the Southern Oscillation
Index falls below a negative 0.5. According to this definition,
there has been 40 El Nino events since 1933. However most of these
were either very short-lived and had no impact, or they were weak
and produced little impact on world weather patterns. Thus, the
market pays attention most when the five-month running average is
less than a negative 1.0, the NCEP's definition of a moderate or
strong El Nino. Since 1950, there have been only 11 El Ninos that
fit this description; this year's event makes it an even
dozen.
In our analysis of El Nino's impact on U.S. markets, we
chose to study U.S. yields in the summer following a moderate-to-
strong El Nino and compare them versus the prevailing yield record.
What we found is that U.S. corn yields were very respectable when
measured against the yield record in eight of the 11 years since
1950 that have experienced an El Nino, or 73% of the time. In five
of those years, the U.S. corn crop achieved a new record yield; the
yield was the second-highest at the time in two years and third-
highest in one year. There were only two droughts out of the 11
years–1983 and 1988. In 1995 yields suffered not from drought
but from heat during reproduction and then an early frost.
Those
who are touting the potential for a Corn Belt drought next summer
argue that the likelihood increases if the El Nino ends in the
spring. However, there is little correlation with droughts in the
U.S. Midwest in the summer following a moderate-to-strong El Nino
event. Specifically, there have been only four major droughts since
1950: 1974, 1980, 1983 and 1988. Only in 1983 and 1988 was there a
major El Nino event, and both ended in the spring. So, at best,
history shows that there is no more than a 50/50 chance that a
drought in the Midwest will occur after a major El Nino event,
which typically end in the previous spring. This El Nino is
expected to extend beyond next spring, possibly into the summer or
fall.
However, there is a strong link between major El Ninos and
corn production problems in South Africa. This year (at least
initially), South Africa is on the dry side and the forecast is far
from wet. This area remains a concern because South Africa is a
major corn exporter; the USDA projects 1998/99 corn exports at 1.0
million tonnes.
We continue to find it difficult to link major El
Nino events (even those that end in the spring) with a drought in
the U.S. Corn Belt. Nonetheless, other market participants and the
media are not going to let go of this bone. Instead, expect to see
media coverage ad nauseam of this El Nino–coverage that may be
enough to generate more buying enthusiasm as the human mind
continues the endless quest of trying to correlate one event to
another outcome.
Although El Nino may be the scapegoat, we
believe that the current volatile, nervous market is the result of
other factors, such as the USDA's current projections of low U.S.
ending stocks and a tight world balance sheet. These two factors
underscore that both the United States and the world have little
margin of error in handling any production shortfall in the 1998/99
season. Probably almost as responsible for the current market
emotion is that the last two major droughts (1983 and 1988)
happened to follow major El Nino events. However, no one seems to
notice that since 1987, there have been three other major El Nino
events that did not produce droughts; indeed new record yields were
set in two of those years.
Tom
Levis
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