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Daily Intelligence Briefing

Thursday, April 29, 2021

Identifying Change-Driven Investment Themes – Five sections, explained here.

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Water May be a Hot Commodity as Drought Brings Heightened Crop and Wildfire Risks to the US West

Summary: The Western US has been heating up at a record pace, with 76% of the region experiencing some form of drought. Limited snowpack from a relatively mild winter is rapidly melting away, leaving major rivers and lakes well below normal water levels, a worrying sign as wildfire season approaches. Multiple states across the US West are expected to declare water shortages, following a trend seen in different parts of the globe as water supply dwindles below levels necessary to meet the demand of a record dry summer.

Related ETFs: Invesco S&P Global Water Index ETF (CGW), Invesco Water Resources ETF (PHO), Invesco Global Water ETF (PIO)

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US West Drought Heating Up Wildfire Concerns

As MRP has previously noted, almost half of the United States is currently experiencing some level of drought. For the US West, the situation is dire, and it only looks to get worse as the summer rapidly approaches. This time last year only 27% of the West was considered to be in drought, a number that has skyrocketed to 76% this year.

In California, the drought is expected to add fuel to this year’s wildfire season, which is already seeing heightened activity earlier than usual. In 2020, California experienced a catastrophic wildfire season, in which 4.1 million acres of land were consumed by wildfires. Per the San Francisco Chronicle, fire agencies and experts have already recorded 1,900 acres burned this year, more than twice the level of activity compared to the five-year average.

This past winter did not help alleviate any of drought concerns, as only 25-50% of normal rainfall fell across the Southwest and California. California on it’s own is 70% below normal for total precipitation this water year, which spans from October 1, 2020 to September 30, 2021.

As CBS writes, a mild winter, a natural dry cycle and human-caused climate change are leading some scientists to believe  this year’s drought will be the worst on record and may be the beginning of a megadrought. These factors combined have thrust water into the spotlight, and the current supply does not come close to the demand needed to manage this new normal.

Water Already in Short Supply

These dramatic climate shifts have led experts to believe the US Bureau of Reclamation is likely to issue a Level 1 Water Shortage Declaration this summer for the first time in history. The order would instruct the residents in affected states to cut their water consumption, reducing usage by 10%. This aims to alleviate the effects of limited snowpack rapidly melting away and leaving major lakes well below typical water levels.

The Colorado River, which flows into major lakes such as Lake Powell and Lake Mead, provides water for 40 million people and 5 million acres of farmland. This year, the amount of water flowing into Lake Powell is 45% of the normal amount, and Lake Meade is only at 40% of usual water levels.

The decline in snowpack in 2020 does not seem to be an anomaly either, as over the past 40 years snowpack has dropped roughly 25% across the US Western states. Lake Mead, which supplies water to 25 million people across Arizona, Nevada, California and Mexico, has seen steady water level contractions since 1984. As water supply diminishes, more and more states are likely to announce mandatory water restrictions.

The drying up of available water will undoubtedly effect the amount of water US farmers will be able to utilize. That marks yet another sign that food inflation is likely to continue kicking up in the months ahead, even as corn and wheat futures have broken out to 8-year highs. MRP recently added LONG Agricultural Commodities to our list of active themes.

Any hopes of precipitation coming to the rescue seem unlikely as well. Just this week thundershowers, lasting about two days, covered the southwest, but are considered to be a ‘band aid fix’ to a long-term drought.

Rising temperatures, inadequate snowpack, and worries of a disastrous wildfire season could drastically change what the US West considers to be ‘normal’ conditions. CNN reports these dramatic shifts could lead the aforementioned ‘megadrought’ to persist long past this year, in which water scarcity and conservation would become commonplace across the West, and ultimately the globe.

Globally, Water Conservation Should Continue to Move Mainstream

Globally, water shortages will continue to impede industries and raise concerns of what a drier future may entail. Per the BBC, Taiwan is currently facing the worst water shortage in 56 years, with many of its reservoirs falling below 20% capacity. They have implemented water conversation tactics in three major cities, limiting usage two days a week by up to 20% reduction.

Experts noted Taiwan should have seen the signs of worsening drought early on, as the number of rainy days have decreased every year since the 1960’s. The US should take note and continue to act early on water conservation in order to avoid worsening shortages in the coming years.

Droughts are impacting the global economy as well. As Bloomberg recently reported, key South American waterways are drying up at a record pace. Argentina’s Parana River has reached the lowest levels since 1989, as parts of Brazil have seen precipitations shortages every wet season for the last 13 years.

As droughts and water shortages are becoming common occurrences across the globe, we will likely see dramatic shifts in behavior and increased water conservation strategies. The US West is just the most recent region to see the effects of a major drought and should take note to act early on the worrying climate trends. Water should continue to be in high demand throughout the rest of 2021, and potentially longer as shortages are increasingly declared across the West.

For Investors

At the time of writing, the Nasdaq Veles California Water Index (NQH2O), the futures contract which provides exposure to California water scarcity, has climbed to $831.97, a 66% increase year to date. Analysts at WestWater Research see the prices of California’s spot water market climbing even higher to over $1,000 per acre foot this summer.

As of April 26, 2021, the Invesco Water Resources ETF (PHO) has returned 13.11% year to date, and the First Trust Water ETF (FIW) has returned 14.78% over the same period. In comparison, the S&P 500 (SPY) has returned 11.70% in 2021.


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