How Inflation Affects The Price Of Commodities

Wondering how inflation affects the price of the commodities? 

The rising commodity prices usually indicate impending inflation. This is because when commodity prices rise, the price of products produced using commodities increases as well. 

But today the correlation between commodity prices and inflation is often negative. 

The reason? Commodity prices comprise only a fraction of the total costs we pay for consumer goods, so price increases may or may not lead to inflation. 

Let’s explore how the government controls inflation, how is inflation measured, and how it affects the price of commodities. 

We’ll also cover commodity prices in developed and emerging economies, the pros & cons of investing in commodities, and how fine wine is the ultimate inflation-resistant commodity.

How Do Governments Control Inflation?

Inflation indicates economic growth, and most governments target a 2% annual consumer inflation rate. But high inflation levels that outperform economic growth reduce the currency’s purchasing power more than most households can keep up with.

Governments and Central Banks maintain healthy consumer price inflation levels (and slow down rising inflation) through their monetary policy. In the United States, the Federal Reserve Bank maintains the public's purchasing power by:

• Buying/selling government bonds. 
• Raising/lowering the national interest rate.

If the Federal Reserve Bank sells government bonds, it removes cash flow from the economy because it’s taking people's money in exchange for the bonds. If people have less money to spend, economic activity slows down, and they’re encouraged to save or invest their money.

By raising the interest rate, the Federal Reserve slows down economic activity because taking out loans is now less appealing since you’ll have to pay more interest. 

Interestingly, savvy investors monitor the Federal Reserve Bank’s inflation expectations and take advantage of high inflation levels by investing in commodities that keep up with (or outperform) inflation.

But how is inflation measured? 

How Do Governments Measure Inflation?

In the United States, the Bureau of Labor Statistics measures the inflation rate using the Consumer Price Index. 

A change in the Consumer Price Index reflects the price change in a basket of consumer goods. So, a rising CPI means higher inflation, meaning everything from food prices to gas prices increases.

Some goods respond to price changes more quickly than others. For example, gold and oil prices change daily, sometimes even every minute. You can see this every time you watch the news or check commodity markets online. Gas prices change often but not as frequently, and other commodity prices like milk increase more slowly.

Historically, commodity prices were great indicators of impending inflation because commodities help produce other goods. For instance, gasoline production requires refined oil, and natural gas helps in plastic production. So, an increase in oil prices also increases gasoline prices due to the rising input cost and oil’s price change - contributing to higher inflation. 

However, the correlation between commodity prices and consumer price inflation isn’t as strong as it used to be. Modern research indicates that commodity prices may no longer be good inflation indicators.

How Does Inflation Affect The Price Of Commodities?

Historically, the relationship between commodity prices and inflation was strongly positive.

However, there has been a deterioration in the role of non-oil commodity prices as inflation indicators.

Non-oil commodity prices generally responded quickly to increases in demand and reflected systemic shocks. An example of a systemic shock is a hurricane that decimates regional agricultural production - increasing food prices. 

However, the correlation between CPI inflation and commodity prices depends on why prices are changing and which commodities are affected.

For example, steel comprises about 10% of the manufacturing cost in vehicle production. So, a rising price should significantly impact the cost of cars since it’s a major input cost. But, producers rarely pass all these costs onto consumers by charging a higher price. 

Instead, manufacturers absorb the costs when they increase and enjoy margin improvements when they decrease. This means commodity prices are actually more volatile than consumer inflation.

In fact, over the past 10 years, the correlation between major commodity prices and CPI inflation has been negative (except for crude oil.)

However, this doesn’t mean the relationship is always negative. For example, a systemic shock, like adverse weather conditions in 2021, had a significant impact on wine supply and prices. A decrease in supply raised wine prices - contributing to higher inflation rates.

Interestingly, the correlation between commodity prices and inflation is stronger in some economies than in others.

Commodity Prices In Developed & Emerging Economies

The relationship between commodity prices and inflation isn’t the same in developed and emerging economies.

In developed economies, rising prices in the commodity markets contribute less to rising inflation than in emerging economies, thanks to the prevalence of their services sector.

On the other hand, developing economies are more exposed to changing commodity consumer prices, especially price changes in agricultural commodities like food and energy.  

Now, let's explore the benefits and drawbacks of investing in commodities.

Pros & Cons Of Investing In Commodities

The main benefit of investing in commodities is that they help you diversify your portfolio. So, if you invest in commodities and stocks and the stock market declines, your commodity investments can still generate positive returns.

Furthermore, commodities can still provide inflation protection and help maintain your purchasing power, especially in-demand commodities like oil and fine wine.

A downside to investing in some commodities is their market volatility. Commodity prices are heavily influenced by demand, supply, and technological factors.

For example, if technology in the renewable energy sector improves, demand for natural gas will decrease, and the price will fall. And if supply chain issues affect the orange supply, there will be a price increase in orange juice.

Now, let’s look at a truly inflation-proof investment - fine wine.

Fine Wine: An Inflation-Resistant Commodity

Fine wine provides inflation protection like other commodities but doesn't have the same market volatility.

It exhibits incredible market stability because a bottle of fine wine gets rarer the longer you hold onto it because of consumption. So, your investment actually becomes more secure over time.

Also, as inflation increases, fine wines see a price increase, meaning as inflation increases, your bottles sell for a higher price.

Furthermore, fine wine investments generate lucrative returns that outperform inflation. For instance, fine wine generated 19% returns in 2021, and the annual inflation rate in the USA in 2021, according to the World Bank, was 4.7%. So, if you account for inflation, fine wine generated 14.3% real returns in 2021.

But how do you begin your fine wine investment journey?

Here are some different ways you can invest in wine:

• Buy, store, and sell bottles yourself
• Attend and bid at wine auctions
• Purchase and sell wines through brokers
• Invest in wine stock and bonds

But, investing in wine can be tricky.

Knowing which bottles will appreciate and when to sell them requires lots of research. Also, you’ll have to store your bottles at the correct temperature and humidity. Furthermore, finding a reputable broker to sell your wines can be time-consuming.

The simplest and easiest way to invest in fine wine is to partner up with a trusted wine investment platform like Vinovest.

Vinovest’s advanced AI-based algorithm considers thousands of wines and generates a portfolio for you. Then, its Master Sommeliers hand-select the wines that best reflect your investment preferences.

You can then store your wines in climate-controlled bonded warehouses and have your wine sold at the right time. Or, you can have your wine delivered to you when you like.

Guard Against Inflation With Fine Wine

Although the correlation between inflation and commodity prices has diminished in recent years, they can still provide inflation protection and help maintain your purchasing power. 

Luckily, fine wine is a commodity that provides stable and lucrative returns to your investment portfolio that outperform inflation. 

Sign up with Vinovest today and invest in rare and authentic wines from around the world.