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Drought Hurts Brazil’s Economy, Helps Commodities

São Paulo, Brazil was once nicknamed Cidade da Garoa, or the city of drizzle.

But that name hasn’t fit in years. The city of 20 million people is now the epicenter of Brazil’s worst drought since the 1930s.

The drought is a threat not only to the many agriculture commodities grown in the country, but also to Brazil’s economy.

A Drought for the Ages

The drought situation in Brazil is perilous.

São Paulo, the world’s 12th biggest city and Brazil’s economic center, gets its water from two reservoir networks – the Cantareira and the Alto Tiete. The reservoirs are nearly depleted at 6% and 15% capacity, respectively. And that’s after the “peak” of this year’s rainy season.

And while the country did get some rain recently, it is unlikely to put much of a dent into the reservoir capacity deficit.

The country’s southeastern states of Rio de Janiero, Minas Gerais, and Espírito Santo, have been affected too. Already, 71% of São Paulo’s residents and 36% of all Brazilians have faced problems with the water supply this year.

And it’s going to get worse…

Just a few short months ago, the central Brazilian government said water rationing wasn’t necessary.

But now, it says that it’s likely that the country’s three largest metropolitan areas – São Paulo, Rio de Janeiro, and Belo Horizonte, which includes more than 40 million people – will face some rationing.

Those cities are joining 93 other cities in Brazil that have already instituted some water rationing.

Water utility Sabesp (SBS) predicts it may have to implement a drastic rationing plan, with five days every week of NO water access in the affected regions of the country!

But wait, it gets worse…

Lifeblood of the Country Scare

You see, Brazil gets about 70% of its electricity from hydroelectric dams. And as the water runs lower, less power will be generated.

In Brazil’s southeast and central heartland, the main hydroelectric reservoirs are at a mere 17% capacity. That could mean electricity rationing is just around the corner, too…

During a less severe drought in 2001, the government ordered a 20% cut in electric consumption.

The overall effect of electricity rationing on the Brazilian economy, which is already on the ropes, may be drastic, as the affected region accounts for 60% of the country’s GDP.

Brazil’s once-robust economy was already forecast to post zero growth in 2015. Now, the effects of water and electric rationing may lop 1% to 2% off of that, throwing the economy into a recession.

Inflation, already at 7%, could climb, too, as both Brazil’s citizens and companies face higher costs for basic necessities.

A negative GDP is obviously bad news for holders of individual Brazilian stocks or exchange-traded funds that invest in a basket of Brazilian stocks, such as the iShares MSCI Brazil Capped ETF (EWZ).

But it’s not all bad news…

Rising Through the Dust

The drought it expected to push the price of certain commodities way up.

As I’ve detailed before, the output of some crops, such as Arabica coffee, will definitely be hit. In 2014, Brazil’s drought caused Arabica coffee prices to spike around 50%, while other commodities were falling in price.

This year coffee outputs will be affected once again. In the coffee-growing region of Minas Gerais, the government has already asked that water usage be cut by 30%. This is bad news since that region alone accounts for 50% of Brazil’s coffee production.

The yield this year for Arabica coffee is expected to be about 40 million, 132-pound bags at best. That would be down 12% from 2014. And last year’s smaller crop already left the country’s inventory of coffee at levels not seen in a decade.

The Brazilian drought is sure to impact the world’s biggest producer of sugar cane, too. Especially since roughly 90% of the country’s sugar is grown in the drought-stricken regions.

Already, the drought lowered Brazil’s sugar exports to a six-year low. According to RCMA Group, the ongoing drought may knock off about 10% of the country’s sugar output. This will likely cause the global sugar industry’s first supply deficit in five years and raise prices.

Soybeans will also be affected. Brazil is now the world’s biggest producer of soybeans, and forecasts of a harvest of 95 million tons is being downgraded rapidly to just 89 million tons.

As the worst drought in Brazil for 80 years continues, certain commodities are certain to get a boost, even as the economy becomes sluggish.

And “the chase” continues,

Tim Maverick

Tim Maverick

, Senior Correspondent

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