In the weeks following the invasion of Ukraine by Russia, the humanitarian and economic implications of the conflict continue to evolve. We continue to hold the people of Ukraine in our thoughts and hope for a resolution soon.
Beyond the destruction the invasion has brought to many areas within Ukraine, we’ve also witnessed widespread consequences in the global markets. While stocks in general have been declining, many commodities have seen their values sharply increasing. Prices from oil and metals to grains have soared amid the disruptions caused by market uncertainty and economic sanctions stemming from the conflict.
In this article we’ll look at why various commodity prices are increasing and what that means for consumers and investors. We’ll also look back in history to determine if recent price movements suggest investors should change their investment strategies and portfolios.
What are commodities and why are their prices increasing?
Commodities are generally used as raw material in the production of food or various goods and generally fall into four categories: agriculture, livestock, energy, and metals. Collectively, these categories provide the food, fuel and the raw material for manufacturing goods for consumers and businesses. Two of these categories in particular have made headlines and could continue to be impacted as the conflict in Ukraine continues.
Oil and natural gas prices increased steadily over the past year as the global economy staged a recovery from the pandemic lows. Since oil prices briefly went negative in April 2020, strong demand has outpaced supply as consumers face fewer restrictions and resume activities that more closely resemble life before the pandemic. The conflict between Russia and Ukraine has added even more pressure to energy markets with oil prices reaching highs not seen since 2008. A barrel of West Texas Intermediate (WTI) breached US$120 in early March and was trading over US$100 on March 18, 2022. This represents an increase of nearly 30% year-to-date.
This recent jump is largely attributable to the market’s assessment that future sanctions may be placed on Russian energy exports. Russia is the third largest oil producer in the world, behind the United States and Saudi Arabia, and sanctions limiting exports would disrupt supply amid an already tight market. Currently, both the US and U.K. have banned Russian oil imports, but many companies were already proactively steering away from purchasing Russian crude in fear of financial risks should sanctions end up being imposed. In addition, companies are aware of the negative optics associated with buying Russian products, which would essentially contribute towards funding the war against Ukraine.
Outside of energy, both Russia and Ukraine are also key producers of agricultural commodities such as wheat and corn. Much of the wheat expected to be harvested this summer in Ukraine lies in the ground over the winter months. As the war continues, landowners may have trouble maintaining, fertilizing and harvesting their crops, which may lead to lower yields this summer. The conflict has also drastically reduced shipping activity in the Black Sea region, which exports most Russian and Ukrainian wheat.
Together, Russia and Ukraine supply roughly 30% of the global wheat export market while Ukraine supplies roughly 17% of global corn exports.1 Export disruption, combined with the expectation of lower crop yields in the Ukraine, has contributed to year-to-date wheat and corn prices surging by approximately 39% and 23% respectively.
Commodity prices increasing in 2022
Effects on consumers
Most consumers have likely heard and noticed that prices for goods and services have been climbing at a faster pace over the past several months. Rising prices, or inflation, has been a hot topic recently with many economists predicting that the pace would gradually slow down over the year as global supply chains worked themselves out from pandemic disruptions, and as pent-up consumer demand dissipated. At first glance, it would appear as though the Russia-Ukraine conflict, and resulting rise of commodity prices, may have a more prolonged impact on the prices paid for certain goods.
Rising commodity prices increase the cost of the goods made by producers who will, in turn, often pass on those costs to consumers. We tend to notice price increases most for products that we purchase frequently, such as grocery items and fuel for our vehicles. All else held constant, higher prices paid for daily necessities leave us with less spending money in our pockets.
Canada, and more specifically, Alberta, are large producers of many of these same commodities that have risen in value. Unfortunately, consumers can’t escape rising prices at the pump or on store shelves even when the commodities come from our own backyard, but at least our economy may find some support in strong commodity prices. Farmers that made it through last year’s drought-ridden harvest will hopefully be able to sell their crop at higher prices; other producers, such as those in the energy sector, should see revenues swell. This additional economic activity can contribute to greater incomes, consumption and government tax revenues. Such factors may help offset some of the negative effects of rising prices in our daily lives. That said, commodity prices would likely diminish fairly quickly should we see a resolution to the conflict in Ukraine—an outcome we remain hopeful for.
Effects on a portfolio
As mentioned above, higher commodity prices may add to inflationary pressures, which can potentially slow economic growth. The current conflict in Eastern Europe has also added challenges for central banks as they try to balance rate increases meant to help curb inflation while at the same time, limiting harm to the economy, which is now on shakier ground. As we’d expect from looking at the history books, increased market uncertainty has also increased stock market volatility, with many major indexes seeing declines.
Oil weighted TSX outperforming other indices
Given recent market moves, it’s safe to assume that most investment portfolios have seen declines over the past few weeks. The extent of the declines and volatility would largely be determined by the portfolios’ allocation to various asset classes and their exposure to the different geographic and business sectors of the global economy.
One sector that has clearly benefited due to higher energy prices has been the Canadian energy sector. As represented by the S&P/TSX Energy Index, the sector is up approximately 19% year-to-date as of March 16, 2022. Given the sector’s recent performance and an optimistic narrative surrounding energy prices, investors may be tempted to increase their exposures. This may be particularly enticing given that most other sectors have recently experienced declines. Though such a move has the potential to play out favorably, there are no guarantees that recent performance will continue over the longer term.
S&P/TSX Energy index total annualized return
(03/07/2022 - CAD)
The above charts illustrate the strength of recent returns, but looking further out highlights the volatility of the sector with 10-year returns below that of the broad market.
Outside of the tragic loss of human life, the conflict between Russia and Ukraine has had a significant impact on various global markets. This has been illustrated by recent stock market volatility and the rapid increase of various commodity prices, with the latter having a negative effect on consumers while benefiting some producers.
Investors should exercise caution if they’re exploring portfolio changes in an attempt to benefit from short-term price momentum in commodities such as energy. As we’ve seen, prices can rise rapidly but reversals can happen just as quickly. This is especially true when the cause of the sharp increase is predominantly attributed to a geopolitical event. This may be a good time to review your portfolio with your financial advisor as your exposures to particular sectors may have changed dramatically given recent market movements. Though it may sound counterintuitive, rebalancing your portfolio by selling recent winners—such as energy companies—and buying sectors that have declined, may allow you to lock in some gains while ensuring you’re not overexposed to the risk of a commodity price reversal. An advisor can help you determine the best course of action.
Source: United States Department of Agriculture
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