Demand expectations may dampen if commodity prices remain elevated

Ravindra Rao, VP - Head Commodity Research at Kotak Securities

Commodities set fresh highs this week as supply concerns intensified with the Russia-Ukraine war entering the second week. Volatility is likely to continue, with no resolution to the crisis in sight. However, the market focus could shift from supply-side issues to growth risks adding to challenges for the sector.

The fighting entered its ninth day as of Friday (March 4) and tensions intensified following reports of an attack on a Ukrainian nuclear plant. Russia and Ukraine conducted two rounds of talks this week without much headway.

Commodities in general have edged up with many setting fresh multi-year highs. The Bloomberg commodity index tested the highest level since 2014 and is on track for its biggest weekly increase since 1974. Brent crude tested the highest level since 2012, while European natural gas prices surged to a record. Among industrial metals, aluminium surged to a record, while nickel jumped to 2011 highs and zinc tested the highest level since 2007.

Russia is a major player in the commodities market and the fear of supply disruption continued to push prices higher. Since Russia attacked Ukraine last week, the US and other countries have imposed sanctions on Russia while multinational companies have reduced exposure to Russian assets and rating agencies have downgraded the country’s sovereign rating.

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Ravindra Rao

Head - Commodity Research|Kotak Securities

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The continuing war, increasing economic pressure on Russia, and lack of any major breakthrough in talks have fuelled concerns that the dispute may not be resolved soon and this has intensified supply risks. With Russia being a major producer and no easy replacement in sight, tightness concerns have kept prices higher. However, none of Russia’s exports has been directly targeted yet. Commodities as a sector have also benefitted from exit from riskier assets like equities and as a hedge against inflation.

While supply risks are genuine and may intensify if Russia-Ukraine tensions escalate, market players need to assess the impact of higher prices on demand. If commodity prices remain elevated, they may dampen demand expectations. Additionally, higher commodity prices may aggravate inflationary pressure globally, further challenging economic activity. Central banks have already started normalising monetary policy and may be forced to act aggressively if inflation spirals out of control.

Also read - Steel prices jump up to Rs 5,000 per tonne as supply chains hit amid Russia-Ukraine conflict

While the market focus may remain on Russia-Ukraine tensions, their reaction may subside if there is no major escalation in tensions. The focus may also shift to central bank decisions, with the European Central Bank meeting scheduled on March 10 and the US Federal Reserve meeting due on March 16. Central banks will counter geopolitical risks against rising inflationary pressure to decide on their monetary policy stance. The Fed is expected to raise interest rates at the upcoming meeting, but market players have lowered the possibility of an aggressive hike.

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