If 2008 Crisis Is A Guide, Expect Rising Rates To Boost Commodities

Source: Barchart

The U.S. dollar index chart shows the currency moved to 103.95 last week, only 0.01 shy of the March 2020 high, which was the highest level for the dollar in two decades, since 2002.

The U.S. dollar is the world’s reserve currency and the pricing mechanism for most commodities. A higher dollar tends to weigh on commodity prices as they rise in other currency terms. The cure for higher prices is high prices as consumers seek substitutes or limit purchases, weighing on the overall demand.

Over the past weeks, we have seen commodity prices decline from multi-year or all-time highs. Crude oil fell from over $130 per barrel, and gold dropped from $2,072 to the $1,860 level. Copper fell from just over $5 per pound to the $4.20 level. Most commodities have corrected on the back of rising rates and a strong U.S. dollar.

Increasing interest rates and a rising U.S. dollar are typically bearish for the commodities asset class. However, 2022 is anything but an ordinary time in history. Three factors could make interest and currency rates take a backseat over the coming weeks and months:

1. The war in Ukraine, sanctions on Russia, and retaliation are causing supply distortions impacting prices in the commodities asset class.
2. The “no-limits” alliance between China and Russia creates an ideological bifurcation between the world’s nuclear powers, with the U.S. and Europe on the other side. With the U.S. and China on opposite sides of the ideological divide, the tensions between the world’s two leading economies create a financial conflict.
3. Pandemic-inspired supply-chain bottlenecks and war-inspired logistical challenges interfere with transporting commodities from producers to consumers, creating shortages in some regions and gluts in others.

Meanwhile, the war and dramatic shift in the geopolitical landscape have incited other factors that fuel global inflationary pressures. Russia recently declared that one gram of gold back 5,000 rubles in a return to a gold standard. If China follows, it will have substantial consequences for the worldwide financial system. Saudi Arabia and Nigeria are discussing selling crude oil to China for payment in Chinese yuan, and Russia is demanding that European energy consumers pay for fossil fuels in rubles. The changes threaten the U.S. dollar’s position as the world’s reserve currency, which would weigh on the dollar’s value. The dollar index measures the dollar value against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. However, it does not measure the dollar’s purchasing power, which has declined along with all other fiat currencies.

While the Fed boosted interest rates by 50 basis points, negative GDP data, which saw the indicator fall by 1.4%, threatens stagflation, rising prices, and declining economic activity. Stagflation puts the central bank in a challenging position as higher rates potentially further choke economic growth. While we may see kneejerk selling after the Fed meeting, the war in Ukraine causing price distortions, the falling status of the U.S. dollar, and overall bullish trends in raw material prices could create lots of volatility as the market digests the FOMC’s first significant hawkish move in years.

The Fed is caught between the highest inflation in more than four decades and a slowing economy. The central bank will look back at 2021 as an opportunity lost for addressing inflation as it was asleep at the wheel. In May 2022, the situation is far more complicated as the war in Ukraine and ideological bifurcation are far more significant for the global economy than U.S. interest rates.

I believe any significant further selloff in commodity prices will be a buying opportunity. If the 2008 financial crisis is a model for the 2020 global pandemic, commodity prices continued to rise until 2011, three years later. We may only be in the middle innings of the post-pandemic commodity rally, created by central bank liquidity, government stimulus, and a delayed reaction by the Fed to tighten credit when it had the chance.

Moreover, the levels of liquidity and stimulus in 2020 and 2021 were far higher than in 2008 and 2009, and the world did not have to deal with the first major war in Europe since World War II that is causing significant changes in the supply and demand fundamentals for all commodities. The shift in U.S. energy policy in early 2021 only complicates matters as it returned the pricing power for fossil fuels to OPEC and Russia, cementing their relationship at the expense of the U.S. and European relations with the world’s leading oil and gas producers.

I continue to favor the commodities asset class. I believe the current correction and the potential for lower prices on the back of higher U.S. rates and the dollar will create a compelling buying opportunity.

A liquid and diversified commodity-based ETF product with weighting towards energy is the Invesco DB Commodity Index Tracking Fund (NYSE:DBC). At just over the $28 per share level, DBC had over $4.439 billion in assets under management. The ETF trades an average of over 4.59 million shares each day and charges a 0.87% management fee.