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Tata Capital > Blog > How do commodity prices react to wars, sanctions, and global tensions?

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How do commodity prices react to wars, sanctions, and global tensions?

How do commodity prices react to wars, sanctions, and global tensions?

Summary

Geopolitical conflicts influence commodity prices significantly due to disruptions in global supply chains, trade routes, and production. Geopolitical events like war, economic sanctions, diplomatic disputes, and regional instability create disruptions in the production and transportation of commodities. This not only results in price rises but also sways investor sentiment, central bank policies, and consumer inflation.

Geopolitical factors continue to be a major influence on global commodity markets. As seen in the recent Iran situation, circumstances such as war, economic sanctions, diplomatic disputes, and regional instability can severely disrupt trade relations, production, and transportation. The outcomes of these disruptions become clearer in the price volatility of commodities such as crude oil, natural gas, precious metals, and agricultural produce.

For investors, international conflicts create risks as well as opportunities. By understanding the relationship between geopolitical conflicts and commodity markets, investors can achieve effective portfolio management and risk mitigation.

What is the relationship between geopolitical conflicts and commodity markets?

Being physical products, commodities are sensitive to supply chain disruptions. Geopolitical conflicts create such disruptions that influence market sentiment and product availability. The effect of geopolitical conflicts becomes prominent through developments like:

  • Supply disruptions due to war and/or economic sanctions
  • Disruption in trade relations between countries
  • Hike in transportation/shipping costs
  • Currency market volatility
  • Shift in investors’ risk appetite
  • Strategic stockpiling by governments

With all these developments occurring simultaneously, commodity prices undergo sharp movements within short spans.

Also, read – Capital market instruments: Types, tools & financial instruments in India

Why do key commodities react sharply to geopolitical conflicts?

The impact of geopolitical conflicts can be seen across commodities, be they energy products, precious metals, or agricultural commodities. If we look at the specific commodities, the reasons and impact can be observed clearly.

Energy commodities: It is observed that energy commodities such as oil and natural gas are affected by geopolitical conflicts due to a few specific reasons.

  • The production of crude oil and natural gas is concentrated in regions that are susceptible to geopolitical conflicts. The Russia-Ukraine war led to a surge in Brent crude oil market prices, peaking at ~$139 in March 2022.
  • Active conflicts can impair production facilities and infrastructure. During the Persian Gulf War of 1991, Kuwaiti oil facilities faced a heavy military onslaught, leading to the damage of hundreds of oil wells.
  • Disruption is created in major shipping and logistical routes. Stand-off in the Strait of Hormuz and around the Red Sea led to disruption of energy security and supplies in the recent Iran-US-Israel hostilities.
  • Economic restrictions on producing countries lead to a supply shortage. European natural gas prices increased sharply in the wake of the economic sanctions imposed on Russia, a leading gas supplier.

Precious metals: Investors regard precious metals such as gold and silver as safe-haven assets. Amidst the uncertainty of a geopolitical crisis, precious metals can help address several investor concerns.

  • It preserves the investor’s purchasing power during uncertainties.
  • It helps investors diversify and spread their portfolio risk.
  • Inflation is a routine outcome of geopolitical conflicts. Gold and silver investments act as a hedge against inflation.
  • To maintain liquidity in a geopolitically stressed market, gold and silver are preferred investments.

Gold attracted investor interest during geopolitical events such as the Russia-Ukraine conflict, the Israel-Hamas conflict, and the recent Middle Eastern crisis.

Agricultural commodities: To a lesser extent, even agricultural commodities can see price fluctuations amidst geopolitical conflicts. The Ukraine-Russia conflict was a recent case in point. The two countries are major global exporters of wheat, corn, and sunflower oil. The crisis resulted in outcomes such as

  • A reduction in crop production
  • Higher transportation costs, and
  • Export restrictions

These factors consequently triggered a supply shortage and food price inflation.

Also, read – Understanding global investments

How did commodity prices react to the Ukraine-Russia & Israel-Iran conflict?

Here is an indicative table highlighting the commodity price rise due to the Ukraine-Russia conflict and the Israel-Iran Conflict thereafter

TimelineGeopolitical ConflictCommodityDuring ConflictNormal Period Comparison
Jan 2022 – Jun 2022Russia–Ukraine WarCrude OilCrossed $120/barrel$70–80/barrel during 2021
Feb 2022 – Mar 2022Russia–Ukraine WarGoldCrossed $2,000/ounce$1,700–1,800/ounce during 2021
2022Russia–Ukraine WarNatural GasPeaked at $9.98/MMBtu (22 Aug 2022)Around $3.50/MMBtu during the normal period
Jun-25Israel–Iran Conflict (West Asia War)Crude OilRose to $76–77/barrelAround $67–70/barrel before escalation
Jun-25Israel–Iran Conflict (West Asia War)GoldClimbed above $3,400/ounceAround $3,200–3,300/ounce before escalation
Apr-26Wider West Asia ConflictBrent Crude OilBriefly exceeded $126/barrelAround $96/barrel before escalation

Conclusion

A proactive investor must keep an eye on geopolitical developments and connect the dotted lines that lead from such developments to commodity prices. Accordingly, they should consider portfolio diversification across asset classes, maintain exposure to precious metals, avoid single asset class exposure and review portfolio risks regularly.

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FAQs

Why do shipping and transportation costs escalate during geopolitical conflicts?

Geopolitical conflicts cause disruptions and hostilities in trade routes. This increases cargo insurance premiums and transportation delays, which increase transportation costs.

How does geopolitical impact on commodity prices impact corporate earnings?

Corporates depend on imported raw materials and global supply chains, which are affected by geopolitical conflicts. These increased costs result in reduced profitability for corporates.

Why are emerging economies more vulnerable to geopolitical shocks?

Most emerging markets rely on foreign capital flows, which may get restricted due to uncertainties. These economies also rely on exports and imports, which are disrupted by geopolitical tensions. This makes emerging economies more vulnerable to geopolitical conflicts.

How does commodity-driven inflation affect government policies?

Governments respond to commodity-driven inflation by revising their monetary policies, interest rates, and currency position. This helps them manage the inflationary pressure in the market.

Can geopolitical conflicts affect currency exchange rates?

Yes, geopolitical instability can lead to currency rate fluctuations. This happens as investors move their capital to stronger markets, thus influencing market sentiment.
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