April 01, 2022

In recent decades, upward spikes in commodity prices were driven by increased demand, like the rapid industrialization of China and the resulting rise of consumer demand in that country. This time, the situation is being driven by supply shortages. Two broad types of supply constraints are at play in the post-covid restart

Delicate Supply Chain. Firstly, the pandemic already highlighted the inflexibility of both worldwide production of various industries (e.g. autos, chips) and the delicate supply chain that previously kept all manufacturers moving smoothly (ports like Los Angeles). Then the Russia / Ukraine war disrupted oil and gas pricing worldwide, striking at precisely the moment when demand had caught up to the production expansion over the prior two decades. Production flexibility is beholden to the weakest link in the supply chain.

Spending Shift. Secondly, the consumer massively shifted spending from contact-intensive services such as gyms, restaurants, and travel to durable goods such as automobiles. Bottle-necks resulted in goods-producing sectors, leading to inflation. In an unexpected twist, the lengthy Covid lockdown led to service workers dropping out of the workforce, resulting in a severe shortage of restaurant workers, adding to wage inflation.

Unintended Consequences of policy changes. Another factor to consider in the mix is the move to net-zero carbon emissions. A gradual, orderly transition to net zero would be the least inflationary path. Unfortunately, governments and consumers are making abrupt changes in their policies and consumption habits, mandating dramatic increases in clean energy production and transportation. For example, China recently pushed to reduce emissions by cutting coal use, surging demand for natural gas. Governments are imposing carbon taxes or increasing regulations, leading to an emphasis on often less cost-effective solutions such as wind farms, solar, or the use of electric cranes in ports. Don’t get us wrong, we are all for cleaner energy policies, it’s just that all renewables combined at this time only account for 20% of U.S. energy production, and it is difficult, if not impossible to make these changes overnight. Don’t forget that many of these clean energy solutions are weather dependent, and tend not to work when the sun goes down (e.g. solar, wind), so electricity storage and/or backup systems are increasingly important (additional costs). With consumers simultaneously shifting to greener products such as soy-based meats and electric autos, it is little wonder that the cost of one of the cleanest burning fuels, natural gas, is up over 100% in the last two years.

In recognition of these changes, which we estimate may persist for several years, in late January we purchased a commodity-focused natural resources ETF (think commodities producers & distributors), for most client advisory accounts. We feel such commodity exposure will provide some protection for our client portfolios in these tumultuous times we are experiencing