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Q and A on the price of oil and other commodities

Wells Fargo Investment Institute - March 29, 2022
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by John LaForge, Head of Real Asset Strategy

Russia’s invasion of Ukraine has shaken the global markets and economy in more ways than we can yet see. According to John LaForge , head of Real Asset Strategy for Wells Fargo Investment Institute (WFII), it could take months — perhaps years — before consumers and investors may experience the full impact that the Russia-Ukraine war will have on commodity prices.  

The large size of commodity production in the region may continue to aggravate inflation around the world, WFII warned in a recent Institute Alert. Energy and food production, in particular, may likely affect European countries, including the U.S. 

As oil prices continue to rise in the U.S., John explains the impact the war may have on the economy and other commodities.

  1.  Why is the price of oil — not just gas — important, and how does it affect consumers?
    Oil is important because most energy costs can be linked back to it in some form or fashion. The gasoline we pay at the pump, the heating oil in our homes, and even everyday products — like shaving cream and deodorants — are often made from oil. If you look around the room you are in today, mostly everything was either made from oil, processed with oil, or transported by using oil. Today, roughly 4% of the average American’s disposable income is spent on energy. 
  2. What impact could the U.S. ban on Russian oil have on the economy?
    Quite a bit. Russia produces 11.3 million barrels of oil per day, which is roughly 11% of world consumption. The other major oil producing countries, unfortunately, do not have enough extra supply to fill the gap should Russian oil not be exported or bought. The rest of the world has extra capacity somewhere in the six to eight million barrels per day range, and it is not always available. The U.S., in particular, has limited extra supply as investors are leaning on energy producers to remain disciplined, particularly in the face heightened anti-fossil fuel policies. Should Russian oil be banned or not bought, oil prices will very likely rise until added supply is found, which could take months, if not years. 
  3. What should investors do as the price of oil continues to increase?
    If you’re worried about the effects of rising commodity prices on an investment portfolio, we recommend an allocation to commodities. Since March 2020, we’ve recommended investors with higher risk tolerances add commodities to their portfolios. Here is what we recommend in the short-term (six to 18 months), which we call a tactical timeframe, and what we recommend over the long-term (10+ years), which we call strategic: 
    • Short-term: We are Neutral on commodities. Neutral means these investors should own a full commodity position. What percentage exactly depends on a client’s financial plan.
      We were tactically Favorable on commodities since March 2020, until March 10 2022, when we downgraded commodities to Neutral. The reason is that commodity prices have increased markedly over the last few months, particularly around the news of Russia invading Ukraine. Should prices settle down and return to levels supported by long-run supply/demand balances, we may return our short-term tactical call to Favorable.  
    • Long-term: We are Favorable on commodities. Favorable means that investors with commodity allocations may take on a larger than normal position, as we feel commodity prices are set to keep rising for years to come. As for which commodities to invest in, a broad basket is ideal for most investors, as individual commodities tend to move together, like a family, through time.
  4. In addition to oil, what other commodities may be impacted as a result of the Russia-Ukraine war, and why?
    Grains prices, particularly, could be impacted by the Russia-Ukraine war. Nearly 25% of wheat and corn exports come from these two countries. On top of that, Russia is a major fertilizer exporter. With Russia recently disclosing that it will hold back fertilizer exports, the world should be bracing for higher food prices in 2022, and possibly into 2023.