Commodity prices are volatile and difficult to predict, however we have built up an understanding of how commodity prices react to changes in the economic environment. This knowledge still doesn’t give us a perfect crystal ball – as the economy is just as difficult to forcast!
Our guide on ‘How to Invest in Commodities‘ gives an overview of the methods used to gain exposure to commodity prices, but this is a fruitless activity if an investor doesn’t understand what drives the values of commodities such as Gold, Silver, Oil and Cotton.
The question posed in this article cannot be answered in a single sentence, but it can be explained by grouping various commodities together into two major groups: Stores of value, and Perishables.
How does a recession affect the price of gold, silver and other stores of value?
‘Stores of Value’ is the name of the group that contains precious metals. Precious metals include gold, silver, as well as platinum and palladium. These are considered to hold their value well during times of crisis, including recessions. This becomes a self fulfilling prophecy, because when recession looms – investors perceive gold to jump in price, therefore they pile into the yellow stuff and cause its value to rocket, as we have witnessed from 2007-2011. Indeed due to such meteoric climbs, one does wonder whether gold is overpriced and overvalued right now. As a result of this relationship, equities and precious metals tend to move in opposite directions to one another.
How does a recession affect the price of perishable commodities?
I group all the industrial metals, agricultural commodities and other commodities e.g. Timber as a perishable commodities. Some of these items may be capable of being stored, but they either deteriorate over time, or become bulky and costly to store in any significant quantity. As a result, perishable commodities are consumed within a limited period of time, and therefore the price will heavily reflect the creation and usage rates of these commodities. As a result, perishable commodities often fall in price during recessions, due to the fall in demand for goods on the international markets. A fall is not guaranteed, because production may also downsize to compensate, but this usually occurs after a significant delay – so low prices may persist for quite some time.