War in the Gulf Upends Global Commodities

Oil sees no quick relief

The anchor of the current market volatility is oil. Prices have skyrocketed since the US and Israel launched strikes on Iran on February 28, leading to retaliatory strikes and the effective closure of the Strait of Hormuz–a maritime chokepoint that normally handles more than 20 percent of the world's oil supply.

In volatile trading this week, US crude oil jumped 10 percent to breach US$110 per barrel. Brent, the international benchmark, rose 6 percent to trade above US$108.

The disruption pushed Brent crude up more than 60 percent in March alone, marking its biggest monthly price gain since records began in the 1980s.

The most recent surge follows a Wednesday (April 1) address by US President Donald Trump. While he paused attacks on Iranian energy facilities until April 6, he pledged further "extremely hard" strikes in the coming weeks and offered no structured path to a ceasefire.

Regarding the critical shipping lane, Trump merely stated, "The strait will open up naturally."

The lack of a diplomatic resolution has forced markets to price in an extended conflict.

“The Gulf conflict looks set to extend well beyond three weeks. Even if the United States withdraws, Iran can continue the fight,” Simon Evenett, Professor of Geopolitics and Strategy at Switzerland’s IMD Business School, told CNBC in an email.

“Claims that Tehran’s capabilities have been obliterated are overstated. Iran can sustain a stranglehold on the Strait of Hormuz. Oil prices would rise sharply. Physical shortages will emerge. Demand destruction becomes a necessity.”

That demand destruction may arrive sooner rather than later. In the US, the national average for unleaded gas has hit US$4.08 a gallon, up from US$2.98 before the conflict. Diesel sits at US$5.51. In Europe, eurozone inflation surged to 2.5 percent in March.

Aluminum takes a direct hit

Benchmark three-month aluminum on the London Metal Exchange (LME) rose 5.9 percent to US$3,492 a ton at the start of this week, pushing toward a four-year peak.

The rally was sparked by Iranian missile and drone strikes over the weekend targeting two major smelters: Emirates Global Aluminium (EGA) in the UAE and Aluminium Bahrain (Alba).

The Middle East produces about 9 percent of global aluminum supply. EGA and Alba are among the world's largest single-site smelters, each producing roughly 1.6 million tons last year.

The attacks caused a loss of power at the EGA site, forcing an uncontrolled shutdown of its smelting potlines. In aluminum production, a sudden loss of power causes the metal to solidify inside the circuits, resulting in catastrophic damage that takes immense time and capital to repair.

Alba has already begun shutting down lines representing 19 percent of its capacity, while EGA confirmed its plant sustained "significant damage."

With LME-approved warehouse stocks already down more than 60 percent since last May, a sustained outage in the Gulf will leave manufacturers across Europe, Asia, and the US scrambling for supply.

Copper’s tug-of-war

Copper is caught in a tug-of-war between the threat of a global recession and impending production bottlenecks.

Initially, the metal was crushed. Between February 27 and March 23, the LME price of copper slid 9.4 percent to US$12,081.74 per metric ton. Investors sold off the metal on fears that high energy prices would stall the global economy, combined with global inventories surpassing one million metric tons for the first time since 2003.

However, copper has recently clawed back some losses, reaching a two-week high of US$12,365 per metric ton on Wednesday (April 1).

This bounce was driven by brief hopes of a war de-escalation, supported by strong Chinese manufacturing data and a drop in Shanghai Futures Exchange inventories.

But copper faces a hidden supply threat from the Gulf war: sulfuric acid.

The Middle East accounts for almost half of the global sulfur trade, much of it moving through the Strait of Hormuz.

Sulfur is essential for producing sulfuric acid, which is used in the solvent extraction/electrowinning (SX/EW) method that accounts for 16 percent percent of global copper production.

Precious metals crash

So far, the biggest shock in the commodities sector is the collapse of gold and silver.

Historically, investors flock to precious metals during geopolitical crises. This time, they are selling them off at a historic pace.

On April 2, gold fell 4 percent to US$4,615.00 per ounce, while silver plunged 8 percent to US$69.84. This follows a brutal March where gold fell more than 10 percent, its biggest monthly drop since June 2013, while silver dropped 19 percent, its worst month since 2011.

The sell-off is being driven by the bond market. Surging oil prices have cemented fears of persistent inflation, prompting expectations that central banks will keep interest rates higher for longer.

As a result, the US dollar has strengthened, and 10-year Treasury yields have spiked to 4.37 percent. High interest rates increase the opportunity cost of holding non-yielding assets like gold, while a strong dollar makes bullion more expensive for foreign buyers.

The massive drop is also being fueled by panicked funds liquidating their positions to cover margin calls in the falling stock market.

Despite the crash, some major banks see a floor. Analysts at Goldman Sachs (NYSE:GS) wrote in a note that they are still constructive on gold: “Our base case assumes no further private sector liquidation of gold nor any additional private sector diversification in gold (beyond the modest boost from Fed cuts).”