TO A TEXT-BOOK ECONOMIST, the world has probably stopped making sense, especially on commodities. The Russia-Ukraine war, for instance, should have bolstered prices of industrial metals such as steel and aluminium, but their prices have plummeted. In a text-book world, inflation would have pushed commodity prices higher, but second half of 2022 saw a significant correction in most industrial and precious metals.

The year 2022 has also challenged conventional monetary policies adopted by countries during war. Countries usually relax monetary conditions when at war, but in 2022, central banks around the globe are tightening purse strings after more than a decade of quantitative easing.

As the post-Covid-19 world expected enormous amount of rebuilding efforts, there was a massive bull run in commodities. Driven by supply constraints, commodity prices soared and created the mirage of a commodity super cycle that fizzled out in second half of 2022. What triggered such an abrupt end to the two-year bull-run? Why are prices coming down despite war and inflation, both of which are generally considered good for commodities? The succinct answer is: Geopolitics.

Currency Vs Commodities Cartel

Commodities and currencies are pawns in the tussle between Russia and the Western bloc led by U.S. On the one end, Russia has weaponised commodities, and on the other, U.S. is using its dollar hegemony to deter ambitions of commodity producing nations.

Global commodity trades are primarily done in U.S. dollar and euro. Thus, commodity producing nations keep their earnings in dollar-and euro-backed assets. Prior to war, around 80% global forex reserves were invested in these two currencies. Threat of seizure of these investments put ‘commodity cartel’ nations at the mercy of ‘currency cartel’ nations.

But after Russia’s invasion of Ukraine, commodity producing nations, primarily OPEC members and Russia, banded together and started pushing up prices by curtailing production. This forced U.S. and other energy consuming countries to induce commodity demand destruction through tighter monetary policies. It is not a coincidence that U.S. Federal Reserve, after running a loose policy for years, raised interest rate in mid-March after just two weeks of Russian invasion of Ukraine. The European Central Bank followed and increased rates after a decade. Since March, most nations in western hemisphere have hiked rates with the prime objective of curtailing demand for commodities. This demand destruction has halted the rally in commodities despite attempts of blocs such as OPEC to push up prices through war and production cuts.

While Russia and OPEC are strategically creating a supply constraint-led price increase, the opposing bloc is employing the counter-strategy of creating money constraint-led demand destruction for commodities.

Ivo Sarjanovic, professor, Agriculture Commodities at University of Geneva, Switzerland, says even considering current prices, Commodity Research Bureau (CRB) Index, an indicator of global commodity markets, is in a long-term downtrend after adjusting for U.S. CPI inflation. He believes commodity prices have been falling since April 2022 due to end of quantitative easing, rising dollar strength and prospects of slower GDP growth or potentially a recession. “If the war stops now, commodity prices will go down further,” he says.

Due to excessive money printing by U.S and other western nations to mitigate the impact of the pandemic, too much money was chasing too few goods. Between April 2020 and March 2022, prices of industrial metals, precious metals, coal, crude oil, natural gas doubled and, in some cases, more than tripled. However, Russian attack on Ukraine forced western nations to change their strategy as they realised that loose monetary policies were indirectly helping commodity-producing nations such as Russia.

The swift rate hikes by U.S-led currency nations and brutal supply cuts by commodity players led by Russia have severely impacted nations such as India that are import dependent. India depends on imports for several commodities right from crude oil to gold and cooking oil to coking coal. India’s forex reserves have declined by $108.2 billion to $524.5 billion since the start of the year as it has to pay more for imports. Rate hikes by the currency bloc have influenced global interest rates and strengthened the dollar index, while supply cuts by the commodities bloc are keeping prices of industrial inputs such as crude oil at higher levels. Indian companies are feeling the heat.

Impact on Metal Companies

Volatile commodity prices have impacted Indian metal companies in two ways — shrinking margins/bottom lines and curtailing of capex plans.

JSW Steel, India’s largest steel company (27 million tonnes capacity), saw its Ebitda per tonne dip by 90% (from ₹30,000 to ₹3,000) between April-June 2021 (Q1 FY22) and July-September 2022 (Q2 FY23). Tata Steel, India’s second-largest steel manufacturer (21.6 MT production capacity), saw its standalone Ebitda per tonne fall from ₹32,712 to ₹21,326 between Q1 FY22 and Q1 FY23. Despite the Ukraine war that gave Tata Steel’s European arm a unique opportunity, consolidated net profit fell 90% to ₹1,297 crore in Q2 of FY23, from ₹12,547.70 crore in the year-ago period.

Jindal Steel, India’s third-largest private steel manufacturer (production capacity of 8.1 MT), saw its Ebitda per tonne decline from ₹28,000 per tonne to ₹16,400 per tonne between Q1 FY22 and Q1 FY23. A lower Ebitda per tonne led to a fall in Ebitda earnings despite the companies selling more steel this year. For example, Jindal Steel sold 1.61 MT in Q1 FY22 and earned ₹4,524 crore, while a year later, it earned ₹2,865 crore despite selling 1.74 MT steel.

Falling earnings and waning demand are also hampering capex plans. Seshagiri Rao, group chief financial officer, JSW Steel, told Fortune India the company has reduced FY23 capex target from ₹20,000 crore to ₹15,000 crore. Rao points out that India exported 18 MT steel last year and earned huge foreign exchange, but this year, the tide has turned. On the one hand, Europe and China are facing demand drought, while on the other hand, export duty on steel has made Indian steel more expensive in the international market. In first nine months of 2022, Europe produced 24% less steel while Chinese demand dipped around 6%. High raw material prices and soaring interest rates forced demand destruction that led to a 40% crash in hot rolled carbon (HRC) steel prices in past six months. From $2,000 a tonne, HRC is now fetching just $800 a tonne, says Rao. Tata Steel has not given capex guidance for next fiscal, but in first half of the current fiscal, it had spent less than 50% of its annual planned capex.

Vedanta’s investor presentation for September quarter shows that the resource company has reduced its capex guidance for aluminium and power division by 40% from $1 billion to $600 million. The cut comes on back of sliding aluminium prices that fell 42.5% from $4,000 per tonne to $2,300 tonne between March and October 2022. Vedanta has reduced its overall capex guidance for FY23 by 20% from $2 billion to $1.6 billion.

The Outlook

Though the Bloomberg Commodity Index Total Return is up about 15% in 2022 (October-end), mainly on the back of high crude oil, coal and natural gas prices, a greater worry is copper prices, which fell 20% this year. Copper has earned the name of ‘Dr Copper’ as the metal is the first indicator of an economy’s health. And ‘Dr Copper’ is hinting that the war between currency and commodity blocs is not going to end anytime soon.

In times of stress, commodities often revert towards their cost of production and in the world’s largest producer of crude oil, U.S., that’s about $40 a barrel, suggests a Bloomberg Intelligence report. If crude oil slides to $40 per barrel, not only would it be bad for commodity nations but also hint at a deep recession in nations in the currency bloc, giving a thumbs-down to both factions and the global economy.

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