Until recently, the commodities market was largely seen as the domain of producers and sophisticated traders.
Not so any more: Rising inflation and the war in Ukraine are stark reminders of how commodities – and the markets, climate and geopolitics that govern them – affect us all.
We’ll break all these forces down in the weeks ahead, but today let’s begin with the basics: Commodities are raw materials or agricultural products that can be bought and sold. Commodities of the same grade are fungible (or interchangeable – we are hearing about non-fungible tokens, or NFTs, lately so this may help to identify the difference).
Commodities are divided into the following groups:
- Energy including oil, gas and derivatives, as well as coal;
- Metals including base (or industrial) and precious;
- Agricultural products including corn, soybean, as well as lumber;
- Livestock including beef, pork and poultry.
Pricing
A commodity’s price goes up the more it is needed or the scarcer it becomes. Conversely, commodities that are abundant or not in demand will see their prices fall. A rising and falling cycle of pricing is common throughout the commodity complex. We will dig deeper into this as we discuss individual commodities in later columns.
Commodities are traded on a futures market (such as the Chicago Mercantile Exchange); futures contracts can be used for price protection or for speculation. For example, a sawmill owner may buy a futures contract to lock in lumber prices for its production, whereas a trader may believe a commodity is going up in price and takes a speculative (”long”) position.
Tracking commodities
Individual commodities are priced daily and the most widely followed index is the CRB (Commodity Research Bureau) Index, which tracks 19 commodities. The accompanying chart shows the Federal Reserve global price index of all commodities since 2003. We see a few points of interest here, especially the 2008-09 market drop, and again in 2014-15, and certainly the rapid rise since March of 2020.
What’s been happening recently?
Commodity prices have been spiking. The U.S. Federal Reserve and the war in Ukraine both play major roles.
As part of the response to COVID, in March, 2020, the Fed cut its federal funds rate by 1.5 percentage points to essentially zero and commenced another quantitative-easing program to steady the bond market. Both of these actions were purposefully inflationary. Higher inflation means a weaker currency so commodities that are priced in that currency rise in price.
To put all of this in perspective, both the U.S. two- and 10-year Treasuries are in the range of between 2 per cent and 2.5 per cent, whereas inflation in Canada and the United States in February rose year over year, 5.7 per cent and 7.9 per cent, respectively. The implication is eroding purchasing power, with prices rising at between 6 per cent to 8 per cent, yet savings only generating 2.5 per cent. Wage inflation is also rising in both Canada and the U.S., which adds to demand for commodities, driving their prices higher.
The conflict in Ukraine is also having a direct impact on commodity prices. Ukraine supplies 11 per cent of the world’s wheat, 17 per cent of the world’s corn and about half of the global supply of semiconductor-grade neon gas. Russia produces 12 per cent of the world’s oil and 17 per cent of the world’s wheat.
Availability of both wheat and corn from Ukraine are expected to be diminished significantly this year because of the war, while international sanctions are limiting the demand for Russian commodities (although we are hearing of countries such as India buying Russian oil at a discount).
A broader humanitarian concern is diminished food availability in countries with low reserves.
There are a myriad of influences affecting commodity prices. We will delve into more detail on a specific commodity in the next column.
Brian Donovan, CBV, is the president of StockCalc, a Canadian fintech based in Miramichi, N.B.
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