Understanding The Market For Weather Investments
During last year's Super Bowl week, the host city of Dallas suffered through a brutal ice storm, punishing winds, snow and single-digit temperatures. This year, Indianapolis, the Super Bowl host city, basked in sunshine and day-time high temperatures in the 50s and 60s. Those two weeks characterize the unseasonable weather throughout much of the country during both winters -- record cold and snow in 2011 and mild and dry in 2012.
We may not have a clue about what Mother Nature decides to bring us, but we can make money from it.
This is America, after all, and there are at least three different ways consumers can invest in the weather.
Reacting To Weather
Extreme weather investing, as it is sometimes called, involves identifying a major weather event, such as a hurricane, flood or monsoon, determining how the event will impact the supply of commodities and other services and investing accordingly. You don't have to be an economist to know the crippling effect that the tsunami in Japan and the floods in Indonesia had on the global economy in 2011.
James Altucher, a managing partner of Formula Capital, an alternative asset management firm, recently identified the top 10 most damaging hurricanes in U.S. history and then examined the S&P 500 to determine which companies' stock rose after each one of the hurricanes. Several companies seemed to benefit, including Campbell Soup, which sells a lot of soup to frightened consumers, who stock up and tend to buy too much; Hill-Rom Holdings, which makes hospital beds, home care systems and patient data management software; Nucor, which makes steel for upgrades and rebuilding; and Toro, which does landscaping for residential, commercial and government buildings.
The downside to extreme weather investing? Sometimes logic doesn’t prevail. For example, Home Depot inexplicably didn’t make the list. The home improvement company’s stock didn’t always benefit after devastating hurricanes, as one might have assumed.
But extreme weather investing isn’t as risky as it might seem because the effects of severe weather can last for months, giving investors assurance that the businesses that should benefit from these events eventually will.
Counting On The Accuracy Of Long-Range Forecasts
Many investors pay close attention to long-range weather forecasts. If the National Weather Service’s Climate Prediction Center, for example, predicts a cold and snowy winter – like the one in 2011 -- very often that news eventually lifts the stock of publicly traded companies that sell winter clothes (Columbia Sportswear, for one), operate ski resorts (Vail Resorts), sell snow removal equipment (Douglas Dynamics) or produce coal (Peabody Energy), natural gas (Q&P Resources) or electricity (Calpine or GenOn Energy).
The downside here is even more obvious. What if the weather forecasts are wrong? What if it’s warm instead of cold or cold instead of warm? That’s why you always need to do your homework on the companies in which you may invest. So if the forecasts turn out to be wrong, you still may come out ahead because – unless you’re a day trader -- you should want to invest in companies with good short- and long-term futures.
Hedging Against The Elements
This is another way to describe investing in weather derivatives, which for the most part is the domain of corporations that want to hedge against the changes in demand for their product that result from weather that is warmer, colder, wetter or drier than normal.
Weather derivatives got their start in late 1997, when Enron made the first trade. Other energy companies followed, hedging against the effect that unseasonable weather could have on demand for fossil fuels. Energy companies pursue this practice more than any other sector, but economists say about 20 percent of the economy is directly affected by the weather – including the travel, construction, retail and agriculture sectors. Many of those industries also hedge against weather events. The trades, most of which occur on the Chicago Mercantile Exchange, are based not only on temperatures but also on rainfall, snow and sunshine.
Relatively small numbers of individuals also trade the weather this way. In the United States, investors can buy derivatives based on the weather in 18 different cities, including Atlanta, Chicago, Tuscon and many others. The most popular weather derivatives are based on temperature, betting that they'll be higher or lower than normal.
As you can imagine, weather derivatives are the most volatile of all weather investments. An overnight forecast change can move the market dramatically and cost investors tens of thousands of dollars or make them that much richer.
As with any investment, investing in the weather requires investors to do their homework and know the risks. Make sure you fully understand the potential downside scenarios before engaging in any weather investments.