Wednesday, March 9, 2022

Commodities Price Shock

The Russian-Ukrainian conflict had somewhat brought about further turmoil for the markets, on top of global supply chain issues, accelerated inflation and the imposition of higher interest rates. Exacerbating the above conditions is the commodities price shock that is already happening and/or may happen in the future assuming the events are going along the trajectory of the current situation.

Commodities price shock happens when there is a quick rise or fall in commodities prices over a short period of time due to the dynamics of the simple economic demand-supply model. If there is a sudden huge rise in demand of a commodity with a given supply, a sudden fall of supply with a given demand, or a sudden rise/fall of demand coupled with a sudden fall/rise in supply, we will have this shock.


The effects of such shocks are huge across markets and the economy as commodities are seen as the “basic ingredients” of industry and society. A lot of sectors and industries, which means numerous companies and workers, are involved in the conversion of commodities from basic items to finished products. Commodity price shocks would send costs increasing and/or profits decreasing, and eventually inflation will rise further (and interest rates would go up to counter this, and so on).


Let us look in detail on the various commodities price shocks happening now:


Crude Oil


The biggest observable shock would be crude oil. Though the price is on an uptrend for the past few months due to the faster than anticipated post-Covid recovery (and the threat of hostilities between Russia and Ukraine), it jumped at least 28% between 24 Feb 2022 (the beginning of hostilities) and now (for Brent and West Texas Intermediate, both widely used benchmarks of crude oil prices). Russia is currently one of the world’s top three oil producers, and the conflict threatened an embargo on its oil, thus the spike.


The impact of the increase was obvious, with the most immediate being the pump prices of petrol and diesel increasing frequently. Further downstream consequences may result in the worsening of global inflation, since oil is used heavily in the transport of goods (cargo aircraft, ships and vehicles) and will directly and indirectly raise the costs of goods and products.


Wheat And Corn


The increase of wheat prices is inevitable since both Russia and Ukraine are among the top ten wheat producers in the world. Soaring 65% year-to-date (YTD), this came due to the potential harvest disruption in the two countries. Furthermore, the price of corn had also gone up slightly above 27% YTD, as Ukraine is also one of the top five producers.


Wheat and corn are staples in many diets, and they are also used for livestock feeds. The surge in prices will result in rise of food costs and, like oil, amplify the global inflation situation.


Platinum And Palladium


By general definition, platinum and palladium are classified as precious metals, along with gold and silver. Both metals are mainly used in catalytic converters, which are devices used in motor vehicles to convert toxic gases in exhaust gas to less-harmful pollutants. In addition, both are used for jewellery and as investment in the form of bullion (bars and coins).


Russia is ranked within the top two world producers of platinum and palladium. Both YTD prices of platinum and palladium had skyrocketed about 18% and 64% respectively. This could put a dent in the prices of cars running with internal combustion engines.


Gold And Silver


An honourable mention, gold and silver, though their prices are not really considered a shock (increase of around 5% for gold and 6% for silver since 24 Feb 2022), they have been traditional “go-tos” in times of market and economic crisis due to their status as safe havens. The inflationary environment also favours these two since they are usually viewed as hedges in such times.


Takeaway Points


As I had mentioned earlier, such price shocks would worsen the global inflationary situation, and the follow-up interest rate hikes, which may in turn affect the financial markets further. Socio-economical and geo-political events are beyond (almost) anyone’s control, but it must be factored in when one is doing fundamental analysis of a company, sector/industry and country/region.


The conflict may signal the beginning of an economic and market dichotomy, which we could see economic blocs forming, partially due to the embargo and sanctions in place, and western companies (and their products and services) pulling out. Whether the pre-conflict economic status quo of Russia be restored is anyone’s guess, though my take would be likely yes, with some minor sanctions in place.


In lieu of the above points, it is important to keep one’s investment portfolio diversified. This also meant the inclusion of commodities asset class, as shown in the preceding sections, in the portfolio, while not meant for earning a quick profit, could provide a dampener effect to reduce volatility.

The percentage increases stated here are as of 7 Mar 2022. Price references are obtained from 

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