War War War

War and sanctions turbocharging already tight commodity markets

Ole Hansen

Head of Commodity Strategy

Summary:  The prospect for a long-lasting cycle of rising commodity prices continues. The war in Ukraine and sanctions against Russia helped turbocharge a sector that was already witnessing a tightening supply outlook.


The prospect for a long-lasting cycle of rising commodity prices that we first wrote about at the start of 2021 continues to unfold. During the past quarter, the war in Ukraine and sanctions against Russia helped turbocharge a sector that was already witnessing a tightening supply outlook. Before government handouts and central banks dumping rates to zero helped drive a post-pandemic overstimulation of the global economy, years of ample supply with steady prices had reduced investments towards new production, thereby leaving producers ill-prepared for the demand surge that followed.

With supply already tightening, the commodity sector was extremely ill-prepared when President Putin ordered the attack on Ukraine, thereby triggering a change in the market from worrying about tight supply to seeing supply disappear. With Russia, and to a certain extent Ukraine, being major suppliers of raw materials to the global economy, we have witnessed some historic moves with Russia’s growing isolation and self-sanctioning by the international community cutting a major supply line of energy, metals and crops. 

The Bloomberg Commodity Spot Index, already showing gains similar to 2021—the best year for commodity returns since 2000—will likely spend Q2 consolidating with a focus on four major potentially market-moving developments: 1) Russia’s willingness to stop the war, thereby beginning the long road to normalising commodity supply chains; 2) China’s slowing economic growth versus its ability to stimulate the world’s biggest commodity-consuming economy; 3) the strength and speed of US rate hikes and their impact on inflation and growth; and finally 4) whether commodity prices, especially across the energy sector and to a certain extent industrial metals, have reached levels that will see demand destruction set in. 

The tightening supply outlook that emerged across global commodity markets during the past year had already driven prices sharply higher before they were turbocharged by the sudden disruption of flows from Russia and Ukraine. As a result, the Bloomberg Commodity Spot Index—which tracks a basket of 24 major commodities spread evenly across energy, metals and agriculture—reached a record high on March 8, thereby recording a stunning and in the short term unsustainable year-to-date increase of 38 percent. A rally of such speed and magnitude lifting the input cost across the global economy carries the risk of slowing the growth and demand for many key commodities. 

While most commodities—with a few exceptions—have since eased back towards their prevailing trends, the price-supporting tightness across markets has not yet shown any signs of easing. Measuring the spread between the first and second futures month we find that a record 21 out of 28 major commodity futures are currently trading in backwardation, a gauge which helps measure the market’s concern about shortfalls and the higher price buyers are willing to pay for immediate delivery compared to delivery at a later date. Another measure shows the one-year roll yield on a weighted average of the components in the Bloomberg Commodity Index has reached a record 12 percent, with the strength currently being carried by the energy sector, cotton and grains.

Energy: Brent crude rallied to within a few percent of the 2008 record high after Russia invaded Ukraine, while fuel products, led by diesel, surged to fresh record highs. This was especially true in Europe where, as major buyers of Russian fuel products, self-sanctioning by several commodity traders raised concerns about the availability of supply. However, within a few days most of the gains had been given back with traders instead turning their attention to renewed Covid lockdowns in China and the US Federal Reserve beginning its long-awaited rate hike cycle. 

With normal commodity supply channels from Russia broken, an end to the war in Ukraine is unlikely to trigger a swift return to normality. The breakdown in relations and trust between Putin’s Russia and the West is likely to take a long time to mend. 

Multiple uncertainties will trigger another wide trading range during the second quarter—potentially between $90 and $120 per barrel. Ultimately the market should stabilise with an upside price risk from reduced spare capacity among key producers and continued supply disruptions related to Russia being partly offset by slowing demand as the global economy becomes increasingly challenged by inflation and rising interest rates. Add to this a temporary Covid-related drop in demand from China and the outlook for a revisit to the March high looks unlikely. 

Key events that could trigger additional uncertainty remain the prospect for an Iran nuclear deal, Venezuela being allowed to increase production and, not least, an increase US shale oil production, should producers manage to overcome current challenges related to lack of labour, fracking teams, rigs and sand. 

For a technical outlook on Brent, please go to Kim Cramer’s article. 

Industrial metals: Aluminium, one of the most energy-intensive metals to produce, raced to a record high during March along with nickel, while copper reluctantly also briefly touched the highest level ever. Current supply disruptions from Russia will continue to support the sector throughout 2022, not least considering the ongoing push towards a decarbonised future. At the same time increased defence budgets in response to the Russian threat will keep demand robust despite the current risk of an economic slowdown. In addition, and supportive for the sector, is the outlook for slowing capacity growth in China as the government steps up its efforts to combat pollution, and ex-China producers for the same reasons being very reluctant to invest in new capacity. 

While the energy transformation towards a less carbon-intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizable portion of Chinese demand relates to the property sector. But considering a weak pipeline of new mining supply we believe the current macro headwinds from China’s property slowdown will moderate throughout 2022. In addition, we also need to consider the prospect that the PBOC and the government, as opposed to the US Federal Reserve, is likely to stimulate the economy, especially with a focus on green transformation initiatives that will require industrial metals. 

While the Ukraine war and Russian sanctions turbocharged these metals to fresh record highs well ahead of expectations, the outlook for most metals remains supportive with tight supply and inelastic supply response likely to drive prices even higher throughout the rest of the year. 

Precious metals: during the first weeks of 2022 the strength of gold surprised the market, not least because the January rally unfolded while US real yields moved sharply higher. The outbreak of hostilities in Ukraine then added a short-lived geopolitical risk premium which saw gold charge higher, only to miss the 2020 record high by a few dollars. 

Heading into the second quarter we see gold eventually adjust to the US rate hike cycle and move higher. Our bullish outlook is based on the belief that inflation will remain elevated, with components such as rising input costs from commodities, wages and rentals not being lowered by rising interest rates. We believe gold is also increasingly being viewed as a hedge against the markets’ currently optimistic view that central banks will be successful in bringing down inflation before slowing growth forces a rethink of the pace of rate hikes and the resulting terminal rate.

Having reached our $2000 per ounce target ahead of time we see the market consolidate its first quarter gains before eventually hitting a fresh record high during the second half as growth slows and inflation remains elevated.

For a technical outlook on gold, please go to Kim Cramer’s article

Agriculture: The UN FAO Global Food Price Index hit a record high in February before the Ukraine war made matters worse by raising the prospect of even tighter markets across key food commodities, from wheat and corn to edible oils. Adverse weather in 2021 has already reduced global stock levels of key food commodities from soybeans to palm oil and corn. In addition, surging fuel prices will not only drive increased demand for biofuels, but also raise the cost of production through higher diesel and fertiliser cost. 

We see an elevated risk of high food price inflation with the focus being weather events and, not least, the duration of the Ukraine war; an extended period of fighting may limit production from Ukraine, a major global supplier of wheat. In its latest monthly report, the US Department of Agriculture lowered its estimates for exports from Russia and Ukraine by a combined 7 million tons to 52 million; this estimated reduction remains clouded in a high degree of uncertainty and could rise sharply in the event of a long, drawn-out war, thereby keeping prices elevated. 

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