3 Quick Trades For The Return Of La Niña

The historic impact of two category 4 hurricanes from the Atlantic in the same year is a hard reminder that weather is playing an increasingly bigger role on our lives. 2016 was the warmest year on record globally, and 2017 is already in a close second place.

While day-to-day temperatures can be unpredictable, larger weather patterns are no longer something investors can ignore. One of the harshest weather patterns could be returning soon, bringing with it bone-chilling temperatures in some regions and droughts in others.

If it does return, then it could mean big moves in one commodity in particular, causing a select group of shares to jump.

How Does La Niña Affect The Weather And Asset Prices?
A cooling in the Pacific Ocean has prompted the U.S. Climate Prediction Center to upgrade its odds for the La Niña weather phenomenon to 62% from just 26% last month. The Australian Bureau of Meteorology also recently said that two of its eight models are forecasting La Niña conditions by year-end.

#-ad_banner-#La Niña is caused by colder ocean temperatures in the Equatorial Pacific and their effect on the wind currents over the Pacific. The weather pattern generally means colder winters in the North and Eastern United States, flooding in parts of the southern hemisphere, and drought in important agricultural regions in Latin America.

Last year’s La Niña was relatively weak and ended in February, but back-to-back events are fairly common, occurring about 50% of the time according to forecasters at the prediction center.

Natural gas futures spiked 50% over the last two months of 2016 on anticipation of colder weather in the United States. More than half (55%) of American households use natural gas for heating, and the Northeast is especially reliant on the energy source. Overall, the energy sector also did well, with the Energy Select SPDR (NYSE: XLE) jumping 10% over the two months, nearly double the performance of the broader S&P 500.

Agricultural commodities also tend to spike during La Niña event as unfavorable crop conditions decrease the yield farmers get on planted acres, decreasing supply and requiring greater fertilizer usage. 

Three Trades For The La Niña Theme
I’m a long-term investor and generally pay more attention to fundamentals to find stocks, but it’s tough to ignore these high-probability short-term trades. La Niña has had a predictable influence on certain assets and stocks in the past. 

Combining the potential for the weather phenomenon to reappear soon with other fundamental data could make for near-term gains on longer-term trades.

The U.S. Natural Gas Fund (NYSE: UNG) is down 18% since January but would be the most direct play on the La Niña theme. Shares are trading just 10% off the 52-week low and 42% below the highs set last December.

The near-term picture for natural gas looks promising, with demand for liquefied natural gas (LNG) rising in 2017 at its fastest pace in six years. According to the U.S. Energy Information Administration, gross LNG exports from the United States are expected to rise 47% to 2.8 billion cubic feet next year as new liquefaction facilities come online. 

I recommended CF Industries (NYSE: CF) in October last year on developing La Niña conditions and other fundamentals. The company is the largest nitrogen fertilizer producer in North America and a smaller player in the European market. The proposed covered call trade I recommended back then ended up generating a 16% return in less than three months. 

Beyond the potential for a frigid winter, La Niña also typically brings hotter-dryer conditions to the American Midwest if it lasts through the summer. The weather pattern was responsible for the 2012 heat wave that caused corn prices to double on a 17% drop in crop yield. Nitrogen fertilizer usage is especially important for corn production since the crop doesn’t produce its own nitrogen, meaning higher volume and prices for producers like CF Industries.

On the fundamental side, CF has over $1.1 billion in balance sheet cash (15% of market cap) and generated $341 million in free cash flow over the last four quarters. Shares pay an attractive 3.8% yield and trade for 2.0 times sales, a 13% discount to the company’s average 2.3 multiple over the last five years.

Cenovus Energy (NYSE: CVE) is an integrated oil company largely focused on oil sands assets. The shares, down 40% this year, have been hit hard by the weakness in oil prices but the company is taking several steps to reverse its fortunes. Cenovus signed a deal earlier this month to sell its Pelican Lake assets to Canadian Natural Resources for $800 million in a move that will dramatically improve its balance sheet. 

It’s also adopting SAP technology for project management at its fields which could improve margins over the next year. Beyond these fundamental improvements, any rise in the price of oil or natural gas this winter could send the shares soaring.

On the fundamental side, an efficiency program appears to be paying off with margin improvements over the last two years. The operating margin has climbed 7.4% since 2015 and turned positive for the last four quarters. Operational cash flow jumped six-fold in the second quarter versus the same period last year and the company generated nearly $1 billion in free cash flow. Shares trade for just 0.7 times sales, a 42% discount to the company’s average 1.2 times multiple over the last five years.

Risks To Consider: Weather patterns can change quickly. Investors should consider booking quick profits on a return of La Niña or using longer-term fundamentals to support investment decisions.

Action To Take: Position for a return of the La Niña weather phenomenon with best-of-breed energy names, fertilizer companies, and energy commodities themselves.

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