Commodity turbulence and price uncertainty continue to dominate most of the world’s markets, reaching critical levels of inflation. After years of historically low values, 2022 has seen inflation rise like never before and seems set to continue on this trajectory, at least for the time being. ‘Inflation’ is everyone’s favourite word right now, and high inflation rates naturally lead to a renewed interest in commodities; the link between the two has always been a point of discussion.
Commodities are often associated with hedging against inflation as they are seen as a great portfolio diversifier. But further than this, commodity prices are often seen as a leading indicator of inflation. One quick reason for this is that commodity prices often respond quickly to widespread ‘economic shock’s that push prices higher almost immediately. Natural disasters are an example of this; when a natural calamity occurs, it places pressure on resources such as energy and food, pushing the prices of those raw materials higher.
However, rising prices do not constitute inflation by simple definition; the reality of the situation is more nuanced than that. Consumers don’t buy commodities directly. Rather, they purchase manufactured consumer products. Therefore, the link between commodity prices and inflation is a bit more convoluted than it might seem, as least from a consumer point of view. But this isn’t 100% true either – it depends on the commodity being purchased in question. Energy prices, for example, have an immediate impact on consumers. Rising oil prices translate almost immediately into higher prices when pumping your gas at the station.
It’s also important to consider that certain areas of the world are more susceptible to ripple effects caused by these rising commodity prices than others. Emerging markets, like those in Asia, are more vulnerable to rises in food prices because there is a shorter end-to-end supply chain in those areas. Therefore, rises in food prices more directly affect inflation than in more developed countries, where the farm-to-table process is much lengthier.
Another connection that can be observed is between the US dollar and commodity prices. History seems to discern a pattern where commodities tend to fall in price when the dollar strengthens. This may seem intuitive at first, but there are a number of reasons for it. Commodities tend to respond to changes in the dollar’s strength relative to international markets rather than its domestic performance. Additionally, a strong US dollar will impact inflation through commodity prices rather than through consumer goods.
These correlations aren’t always set in stone, especially when it comes to agricultural commodities. Commodity inflation movements are dependant on the cause of what’s driving the change in prices. And over time, this relationship has become less simple. This is partly due to globalisation – with so many complex supply chains snaking all over the world, the consumer economy is less sensitive to commodity prices than it used to be. However, the magnitude of changes that have been occurring recently, as a result of COVID-19 and the war in Ukraine, among others, is so great that consumers are actually feeling the effects of these wildly fluctuating prices for the first time in years.
Turning to examine commodity prices isn’t the end all, be all of hedging against inflation, but it’s a good starting point. When thinking about inflation and how to approach it, it’s advisable to start by considering the current state of commodity prices.
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