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The ongoing Russia/Ukraine conflict is weighing on global equity markets. That's not surprising. Nor is it surprising that commodities are flourishing against this backdrop.
Year-to-date, the widely followed S&P GSCI(R) Total Return Index is higher by more than 34%. That after commodities ranked as one of 2021's best-performing asset classes. Combine performance with domestic inflation and geopolitical conflict and it's reasonable to expect clients are increasingly inquisitive about commodities.
Specifically, clients are probably curious about whether or not there's more upside to be had with commodities. Obviously, advisors don't have crystall balls and they cannot answer that question beyond a shadow of a doubt. Still, a compelling argument can be made that commodities can run high over the course of 2022.
I'll get into those in a minute, but an interesting factoid to remember is that prior to 2021, commodities finished in the red in seven of the 10 years through 2020.
No Commodities Conundrum Today
As noted above, there are factors in place today exclusive of Russia's ill-fated desire to restore the old Soviet Union that augur well for commodities, notably rampant inflation and the U.S. isn't the only offender on that front.
“In the near-term, we expect inflationary pressures fueled by loose monetary policy and the recent unprecedented expansion of the money supply in the U.S. to provide a strong tailwind for commodity prices, especially if demand for goods and services rebounds with the lifting of Covid pandemic restrictions,” according to First Trust research.
Focusing on the goings on in Russia, many clients may be aware that the country is one of the largest oil producers in the world, but it's rich in other commodities. Wondering why palladium prices are soaring of late? Russia is the second-largest exporter of that metal. Higher palladium prices also mean higher new car prices – more inflation – because that metal is used to make catalytic converters.
Additionally, Russia's central bank is one of the biggest central bank owners of gold in the world. It could liquidate some of that bullion because it's been booted off of major global financial systems or it could find a way to add more, perhaps in a bid to defend the plummeting ruble.
Then there's the supply issue. As advisors know, supply and demand are the driving forces in the commodities market. These days, demand is robust, but supply is low because due to a decade-plus of low prices, commodities producers didn't ramp up output.
“Producers have had less incentive to develop commodity resources and infrastructure over the past decade due to low or falling commodity prices. Along those same lines, energy producers have had an additional disincentive for developing long-term projects due to regulatory uncertainty and a growing bias towards renewable energy production,” adds First Trust. “Who wants to invest in a 20-30 year project, only to be hit with new regulations 5-10 years later that eat up cash flows over the next 10-20 years.”
Commodities and Climate Change
Many clients think of renewable energy and commodities as competing interests, but the reality is the former is dependent on the latter. Think lithium in electric vehicles and silver in solar panels as just two examples.
“The typical electric vehicle battery requires approximately 18 pounds of lithium, 77 pounds of nickel, 44 pounds of manganese, and 31 pounds of cobalt,” notes First Trust. “Solar panels also require large amounts of copper, silicon, silver, and zinc. Time will tell how well producers are able to keep up with surging demand for these commodities.”
Bottom line: It won't be a linear move higher, but commodities could offer clients some more upside owing to the aforementioned multiple tailwinds.
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