Commodity Watch: Traversing inflationary terrain

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" src="/getContentAsset/061c994a-a452-418f-bfa0-f2cf3cf5c577/cb87803a-320c-480f-ab75-7b9029eaaf79/Ahmad-Al-Sati-new.png?language=en" alt="Ahmad Al Sati - insights" title="Ahmad Al Sati - insights" style="width: 180px" class="fr-fic fr-dii"></div><span style="font-size: 12px"><div class="col"><strong>AHMAD AL-SATI</strong><br><br>PRESIDENT OF GEMCORP CAPITAL ADVISORS LLC, PORTFOLIO MANAGER<br><br>Ahmad Al-Sati is Portfolio Manager of the Gemcorp Commodities Alternative Products strategy (GCAP) and President of Gemcorp Capital Advisors LLC, based in New York. He is responsible for leading Gemcorp’s commodities-focused investment strategy and overseeing the firm’s US advisory platform.</div></span></div><hr><p style="margin-left: 0" data-pasted="true">Oil was up ~5x, industrial metals were up ~4x and BCOM almost doubled, yet global inflation remained relatively low during the 2000s. World inflation averaged ~4% (lower for DMs) compared to 7% during the 1990s. Not all commodity price increases are equal. The origin, structure and composition of these cycles matter as much as (if not more than) price hikes.<br>&nbsp;<br>The commodity cycle of the 2000s was spurred by demand from China as it spent trillions to become the world’s factory floor. However, higher input prices were dampened by increased growth rates, more trade and an influx of cheap goods. The world economy overall was on the upswing and thus felt the impact of higher prices less – higher productivity, less reliance on oil and more credible central banks (after past successes) helped. It turns out that higher prices from increased demand and that don’t drain piggy banks or lower purchasing power, don’t necessarily lead to high inflation.<br>&nbsp;<br>Supply shocks do.<br>&nbsp;<br>Supply shocks increase prices abruptly and directly impact savings, purchasing power and economic activity. Pure supply disruptions (especially for a narrow set of commodities) have limited and short-lived inflationary impact as other sources of supply (and substitutes) kick in to offset inflationary pressures (the best cure for high prices is high prices). Yet, per multiple studies, if immediate supply shocks are coupled with increased buying of scarce commodities in expectation of future shortages or as a reaction to uncertainty, then the inflationary impact is significant, persistent and potentially stagflationary. This scenario results in the actual transfer of wealth away from consumers (negative wealth effect) and a cost shock to the economy (with impacts on economic activity and employment). Of all potential inflationary scenarios, this one is the worst.<br>&nbsp;<br>Today, the world is experiencing a supply shock across a bunch of commodities. Storage has acted as a shock absorber, helping manage price increases. Yet, storage is being drained at a rapid clip. For example, oil is about to reach its lowest global storage level on record (executives at the largest oil companies are sounding the alarm). Even if the strait were to open today, continued (defensive) buying of the commodities that were in short supply may keep prices high as companies and countries seek to fill depleted inventories. Thus, a supply shock could then be paired with persistent demand, which has historically caused higher inflation or stagflation.<br>&nbsp;<br>Inflation is corrosive. It means higher interest rates, lower disposable incomes and lower economic activity. It creates economic and voter malaise – no one is happy paying more for stuff. Equities can help portfolios. So can hard assets. This is not to be alarmist, but clear-eyed thinking is key. Being prepared and diversified may assist in traversing the higher inflationary terrain ahead.</p>