How Russia’s invasion of Ukraine has upturned the commodities market

John and I thought it would be useful this week to round up what has happened to commodities since Russia invaded Ukraine.

What commodities does Russia produce? How have markets been affected? What are the investment implications?

It’s worth remembering that after a decade of underperformance, commodities in general were already in a bull market before the invasion.

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If you had to put a date on when the low came, it would be somewhere in early March 2020, at the height of the coronavirus panic, when the oil price went negative.

What a buy that was.

It’s also worth noting that, while the sanctions imposed on Russia have had a devastating effect on its economy, they have also inflicted – or are about to inflict – a certain amount of pain on ordinary Westerners in the form of food and energy price inflation. Never mind oil going over $100 a barrel, the wheat price has almost doubled.

There is a cycle to commodities. Years of investment leads to a shortage of supply; prices go up, which attracts speculators and investors. Producers, as a result of higher prices and increased investment, produce more; prices come back down again.

The problem is, human beings being what they are and markets being what they are, rises and declines always seem to go too far. As a result, you get these speculative blow-off tops and vicious bears, both of which quickly get forgotten when the other is rampant.

Here’s what’s happening in the energy market

Let’s start with natural gas. Russia is the world’s second-largest producer. The US is actually top dog when it comes to natural gas, but it is the fact that Russia supplies about 40% of Europe’s natural gas that is causing such upheaval. Italy and Austria are almost entirely dependent on Russian gas; about a third of Germany’s gas comes from Russia, while here in the UK, about 5% of our gas is Russian. (Our biggest foreign supplier is Norway – I guess we have to hope Norway doesn’t decide to invade Sweden – or indeed Britain.)

The Financial Times reports that European wholesale gas prices hit €335 a megawatt hour, up from about €16 a year ago; the UK has also seen over 1,000% inflation in gas prices. This was already happening – the invasion has made it worse.

Moving onto crude oil, Russia is responsible for about 10% of global oil supply, and around 30% of EU supply. Germany, for example, sources 34% of its oil from Russia.

Oil is in a runaway bull market that has gone parabolic (I’ve been saying be long oil for a long time, as regular readers will vouch): Brent is at around $130/barrel and a re-test of the 2008 highs of $150 looks a given.

It’s a minority view, but there are many who argue that it was $150/barrel oil that triggered the global financial crisis, by the way – the last thing we need right now is another one of those.

With bans on imports pending, the oil shock of the early 1970s could end up looking like a doddle.

And then there is the underreported but perhaps equally important energy supply that is coal. Russia is the world’s third-largest coal (thermal and coking) producer, with over 50% of hard coal received by German power generators and steelmakers coming from Russia in 2021.

Whether coal, gas or lack of wind, this all translates into runaway electricity prices across Europe.

How Russia’s invasion of Ukraine is affecting metals and grain prices

We come to metals next. Russia is the world’s largest producer of palladium and nickel. Nickel is vital to the steel and battery industries; palladium to the automotive sector and anywhere that requires its properties as a catalyst. The prices of both have gone bananas.

Palladium now sits at all-time highs of $3,200/oz, having been at just $500 a few years back.

Nickel – wow. It went from $25,000/tonne to over $100,000 in just a few days. The London Metal Exchange has had to suspend trading. A Chinese nickel company got on the wrong side of the trade and reportedly got a margin call rumoured to be more than $10bn, which its bankers are currently trying to sort out. Goodness knows how that is going to pan out, and I pity small traders with open positions.

Russia is also the world’s third-largest steel exporter, the fourth-largest aluminium exporter, the fifth-largest iron exporter and the eight-largest copper producer.

As for precious metals, it is the world’s largest silver producer, and second-largest producer of gold and platinum. It’s no wonder you’ll struggle to find me a metal that has not gone up in price.

And so we come to stuff it grows. Russia is the world’s fifth-largest producer of wood, and the number one exporter of both grains and fertiliser.

On this front, Russia didn’t need Western sanctions – it has ceased its own fertiliser exports in an effort to tackle domestic inflation. About 20% of global fertiliser supply is Russian and fertiliser cost inflation is causing big problems for farmers worldwide.

As for grains, Russia is the world’s largest wheat producer, responsible for about 17% of global supply. As a result, the wheat price going “limit up” (hitting the maximum daily gain allowed by the exchange) has become an almost daily occurrence. The price has gone from around $5 a bushel last year to nearly $13 today, breaching its 2008 all-time highs.

Prior to this crisis Russia was the 11th-largest economy of the world and it supplied roughly 17% of global commodities. To suddenly exclude a country of this size and strategic importance from the global economy is without precedent.

No wonder commodities prices are rocketing.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.