Inflation and conflict are at the centre of our analysis this quarter as we explore, from the unique perspective of the commodity markets, how much of the recent run up in prices is structural rather than temporary. First Covid, then the invasion of Ukraine have clearly supported whatever inflationary forces were building in the global economy. But these traumatic events may simply have accelerated processes that were gathering strength for some time, hidden behind a wall of easy liquidity provided by central banks. For example, well before Covid changed so many lives, global interest rates were at record lows while stock markets were pushing all records in the opposite direction. What were the causes of these events?

Valuations are out of whack

Our analysis of the global macro environment identifies some of the extreme valuations that were visible even before covid. In normal times, one unit of the S&P500 index (converted to dollars) has on average bought about 35 or so barrels of oil. At the end of 2019 stock prices were some 60% higher than this in real oil terms, a sure sign of emerging inflation. At the peak, when Covid hit and the oil price collapsed, the S&P500, even in its depressed state, was able to buy 131 barrels of oil. These extreme gyrations in global prices normally hint at deeper structural forces that have been building for some time. For example, the last time the S&P500 was anywhere near these levels in terms of the oil price was back in 2000 around the time of the dot com boom. It is no coincidence that as the S&P500 was reaching these extreme levels global interest rates were heading in the other direction.