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Asia is drying up – investors, pay attention

A freak weather phenomenon is spreading across Asia. Lars Henriksson explains what it is, and what it means for the region’s economies.

14-4-28-malaysia-drought
Malaysia is in the grip of a drought

In 1997-98, I lived in Kuala Lumpur. During that time, the country was suffering through a drought and there were a few months where every night, a water tanker would stop outside my apartment block. One by one, everyone in the block would file out with buckets to collect their ration of water for the following day.

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Malaysia is not the type of country you'd expect to have a water ration. On average, it has an annual rainfall of three metres about five times more than the UK. But these droughts are becoming increasingly common in Southeast Asia there's one happening as we speak.

Right now, friends tell me that sales of buckets and other water containers are going through the roof. Water bottles are being snapped up and companies are hiring tankers to secure water in order to keep their factories going.

Coffee shops carry signs in their window informing customers that "no hand-crafted coffee is available". And perhaps worst of all, office workers are showing up to work with towels under their arms, hoping to use the toilets to freshen up.

These droughts are part of a freak weather phenomenon spreading across tropical Southeast Asia. Today, I want to explain what it is, why it's soon going to be a regular fixture of Southeast Asia and what it means for the region's economies.

The last time this happened, it was devastating

The more scientific term is 'Southern Oscillation', which NASA defines as an abnormal warming of surface ocean waters in the eastern tropical Pacific. El Nio heats the Pacific and drives rain away from Southeast Asia and the subcontinent.

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Nobody really knows why this is happening, but it has a severe impact on weather conditions in Asia, South America, Africa and Australia.

There are mild and severe forms of El Nio which tend to occur in fairly regular intervals: mild every four to five years and severe every 20 years. According to the University of South Wales, the 1997-98 El Nio was the severest ever recorded since data started to be collected in 1980, causing $35bn in damages and around 35,000 deaths worldwide.

Australia and Indonesia experienced extreme droughts and wildfires, while there were catastrophic floods in the eastern equatorial region of Ecuador and northern Peru.

The Australian weather bureau warns about a strong possibility of El Nio. Six of its seven models suggest El Nio thresholds may be exceeded as early as July. What's more, the current water temperature in the Pacific Ocean is on par with the 1997-98 level. Let's look at how that will affect South East Asian economies.

We were right about palm oil

According to BoA Merril Lynch, a confirmed El Nio would push inflation up to 8-10% and force the Reserve Bank of India to postpone any rate cuts until 2015. It could also shave off 50-75 basis points from its 5.75% GDP forecast for 2015.

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The prolonged drought is also lowering the water levels of inland waterways that are used for transporting commodities such as coal and nickel ore in Indonesia.

We have seen the price of the latter spike at the London Metal Exchange over the last month. However, admittedly, the relationship is less clear-cut due to the Ukraine debacle and Indonesia's recent export ban of nickel ore.

In last October's New World report, we pointed out that big palm oil companies were snapping up smaller estates in East Malaysia (Borneo). We said that when insiders are buying, we should take note.

They have superior market intelligence allowing them to track the whole food chain from the sourcing of land, nurturing seeds, planting, harvesting to trading and consumers.

Since then, the Malaysian palm oil index has jumped nearly 17% - more than four times higher than the underlying Malaysian market. If severe El Nio is confirmed, we expect further short-term momentum buying, because a sharp spike in palm oil prices will offset contraction in production.

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Impact will vary depending on areas and age; older and very young trees have a sharper drop in yield versus the young and prime-age ones.

The MSCI Emerging Market Index, which includes commodity-heavy Brazil and Russia, has risen about 100% over the last ten years. These are beneficiaries from the emergence of China and generous global monetary policies.

In contrast, large palm oil stocks such as IOI Corp (MK: IOI) and Kuala Lumpur Kepong (MK: KLK) are three to five baggers over the same period. In my view, the market is trying to price in a long-term structural change.

The study from the University of South Wales warns "this latest research based on rainfall patterns, suggests that extreme El Nio events are likely to double in frequency as the world warms leading to direct impacts on extreme weather events worldwide".

If correct, it would mean that a severe El Nio would occur every ten years. A lot of industries will be watching this development nervously. Investors, take heed!

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