Commodity markets are struggling to catch up to a world turned upside down by war and sweeping international sanctions against Russia.
The London Metal Exchange, a key global price setter for industrial metals, suspended nickel trading on Tuesday after prices more than doubled. Wheat, copper and gold have also been on a tear, while oil, the single most important commodity to the global economy, continued its relentless climb after U.S. President Joe Biden banned the import of Russian fossil fuels to the United States and Britain declared it would phase out Russian oil by the end of the year.
The combination of an unpredictable war, expanding sanctions and booming prices is resulting in an unprecedented wave of uncertainty for commodity producers and investors.
True, there have been supply shocks before – the oil crises of the 1970s being prime examples – but those typically affected only single commodities and were the decisions of key suppliers such as the Organization of Petroleum Exporting Countries (OPEC). It is difficult to recall another case in which a major supplier of a wide range of raw materials was abruptly shunned by its major customers.
“What we are seeing at the 50-year anniversary of the 1973 OPEC supply shock is something similar but substantially worse – the 2022 Russia supply shock, which isn’t driven by the supplier but the consumer,” Credit Suisse investment strategist Zoltan Pozsar warned in a note Tuesday.
The size of the Russian shock reflects the enormous range of commodities the country produces.
“Russia’s central role in global commodities both in depth and breadth is so significant that … the conflicts under way will be transformative,” Edward Morse, global head of commodity research at Citigroup, said in a presentation this past week.
Russia is the world’s third-largest oil producer and the supplier of about 40 per cent of Europe’s natural gas. According to Morgan Stanley, it also accounts for 12 per cent of global production of high-grade nickel, a key ingredient in stainless steel and batteries.
Add in the economic impact of the Russian invasion on Ukraine and the implications for world markets grow even larger. Together, Russia and Ukraine are responsible for 28 per cent of global wheat exports, by Citigroup’s estimate. They are also top-tier producers of myriad other commodities ranging from fertilizers and barley to palladium and lumber.
Threaten that supply and many markets are left looking into an abyss. The speed with which sanctions have been imposed on Russia has stunned traders. The uncertain course of both sanctions and central-bank policy only aggravates the uncertainty.
“Nothing sounds crazy any more,” wrote Michael Tran, a commodity specialist at RBC Capital Markets, in a note Tuesday. He added “it is not unfathomable for [oil] prices to rocket to US$200 a barrel by summer, spur a recession and end the year close to US$50 a barrel.”
This is not his base case, he stressed, but it is not out of the question, given the stresses in the oil market and the wider economy.
Barring a negotiated peace in Ukraine, surging commodity prices are likely to turn up the heat even higher on already red-hot inflation readings in Canada and the U.S. But exactly how policy makers will respond is open to question.
Central banks may decide to aggressively push interest rates higher to reduce demand and control inflation, even if it risks a downturn. Alternatively, they may decide higher rates will do nothing to tame the sanctions-driven boom in commodity prices and instead slow down their planned rate increases to shield economies under stress from rising input costs.
A key question is how traders will respond to the commodity turbulence. There are already signs of stress.
The decision by the London Metal Exchange to temporarily close down trading in nickel reportedly stemmed from a huge short position in nickel accumulated in recent months by Chinese billionaire Xiang Guangda, founder of Tsingshan Holding Group Co., a leading producer of stainless steel.
In a short position, the investor is betting that the price of the shorted investment will fall. If it instead starts rising – as nickel did, on fears of disruption to Russian supply – the investor will face a margin call that asks him to deposit additional money to offset potential losses. Mr. Xiang has apparently not yet done so. According to the Financial Times, he faces potential losses “stretching into billions of dollars.”
The funding pressure on commodity traders is likely to grow, warned Mr. Pozsar of Credit Suisse. Among other factor, prices for non-Russian commodities have shot upward, meaning traders need to borrow more from banks to buy commodities. In addition, anyone who is holding non-Russian commodities and attempting to offset the risk by shorting the related futures is likely facing a margin call as prices soar.
These and other situations could push some commodity traders to the brink.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.