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Inflation is going to stay even higher for even longer

The oil market went bananas this week.

That’s a technical term used to describe a situation where Brent crude oil went from as low as $99 a barrel on Monday to as high as $122 yesterday, only to now settle at something around the $113 mark.

The thing is, while it’s probably the most eye-catching of the commodity markets, it’s far from the only one seeing extreme moves.

That’s not likely to end any time soon.

Commodity prices are back at 2008 levels

Commodity prices are “on track for the biggest weekly rally in more than 50 years”, reports the FT this morning. The S&P GSCI index which tracks raw materials prices, is up 16% on the week, and is at its highest level since 2008.

It’s worth noting that more than half of the index is accounted for by energy-related commodities, so surging oil, coal and gas prices have a big effect. However, the price of everything from metals to grains is higher.

This is, of course, partly due to Russia being cut off from the global economy. Technically, sanctions don’t cover energy but, in practice, no one wants to buy Russian oil for fear of it coming back to bite them further down the line.

As a result, because no one wants to buy Russian oil, demand for the non-Russian stuff is higher. Russia exports five million barrels of oil a day. For perspective, Saudi Arabia does around seven million. So that’s a big chunk of global supply that has effectively been taken out of the picture.

Russia is a major grains and metals producer, so that has a huge effect on those prices too.

While it’s probably the last thing on a geopolitical level that anyone particularly cares about right now, this all presents central banks with quite the dilemma.

Surging raw materials costs drive up prices and thus inflation, and at the same time, the risk is that these high costs will start to destroy demand, and then the global economy ends up in recession.

As Nicolai Tangen, head of Norway’s sovereign wealth fund, summed it up: “This is amplifying the inflationary pressures we’re seeing, through oil and energy, food input, input into fertilisers and other materials. It’s making that situation more problematic. It’s also negative for economic growth.”

That does imply that stagflation – where you get high inflation but weak or non-existent economic growth – is a serious risk now. It’s not the sort of situation that central banks can do a lot about – or rather, they can’t print a load of money and make it go away.

Think in terms of preserving capital rather than growing it

The Russian invasion has exacerbated or crystallised many pre-existing trends. Inflation was already a problem; this is going to make it significantly worse, and make it last even longer. I really wouldn’t be surprised now to see double-digit inflation in the UK and elsewhere within months.

Part of that is the spike in commodity prices. But it goes beyond that. As we’ve said on a number of occasions, the global backdrop had become more inflationary; the war as underlined that, rather than caused it.

For example, one of the great disinflationary forces of the last 20-30 years – globalisation – peaked quite some time ago. We were already moving to a “just in case” rather than a “just in time” world.

This invasion merely makes that official. The pool of trading partners which each individual nation will consider trustworthy enough to rely on has shrunk drastically. Self-sufficiency is an inefficient way to run an economy, but when trust vanishes, it becomes a necessity.

Countries who don’t want to risk relying on the US dollar system lest they be cut out of it in the future will also intensify efforts to establish rival trading and financial systems. That’s not going to be easy, and as I’ve said already, the jury is out for me on how realistic a rival is. But it’s certainly not a recipe for smooth global trade relations.

And of course, high prices for necessities increase the likelihood of domestic unrest. Inflation changes behaviours and those new behaviours start to entrench inflation.

What does it all mean for investors? We’ve already pointed out that in 1970s-style conditions (and let’s not be coy here, that no longer looks like a ridiculous scenario), most assets struggle. You want commodity producers and you want some gold, but beyond that, it’s tricky to point to specific asset classes that thrive or are even especially resilient in this environment.

The main mental shift you probably have to make is that your focus has to fall more on capital preservation rather than growth – thinking in terms of avoiding and managing threats rather than spotting opportunities.

Beyond that, if you haven’t already subscribed to MoneyWeek, then now might be a good time to do so.

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