Update on Russia and Commodities

Russia is a mineral rich country that depends on its natural resources for income. A bear market in commodity prices during much of 2015 came at a very bad time for the Russians. The nation found itself the subject of sanctions leveled by the United States and Western Europe. This cut off certain aspects of trade between Russia and these countries, which hurt the Russian economy.

In the face of sanctions, commodity prices continued to move lower.

Perhaps the most difficult market for the Russians has been crude oil. The Russians are a major producer of the energy commodity and the oil price has dropped from over $100 per barrel during the summer of 2014 to under $50 as of late September 2015. As Russian output stands at over 10 million barrels of crude each day, the current price level coupled with sanctions and lower prices for all other natural resources produced by the nation has resulted in devastating effects on the Russian economy. A plunging ruble has also hurt the Russian economy. During the summer of 2014, one U.S. dollar bought around 34 Russian rubles. Recently, the same dollar bought 66 rubles; the Russian currency is worth almost half what it was just sixteen months ago.

A strong U.S. currency and the prospect for rising U.S. interest rates contributed to the slide in commodity prices. The dollar is the reserve currency of the world and as such, it is the pricing mechanism for many raw material markets.

When commodity prices peaked in 2011, the Russian economy was steaming along. At that time, the Russian ruble traded at around 28 to the dollar. Since then the strong dollar and global economic weakness have contributed to bear market conditions in raw material markets.

During the bull market in commodity prices that commenced in 2004 and lasted until 2011, many producers increased production and the Russians were no exception.

As China grew it became the demand side of the equation in commodity markets, China's thirst for all raw materials supported price and fueled the bull market trend. Recently, economic weakness in China and slower growth has been a depressive factor for raw material prices. Additionally, economic weakness in Europe has hurt commodity demand. A recession in Europe, the recent bailout of Greece and a growing immigration crisis has caused demand for commodities to fall. Moreover, Europe is traditionally the most important trading partner for Russia and sanctions have caused additional strains to the European and Russian economies.

During bull market cycles in commodities, production tends to increase. Higher prices lead to more output. Producers ramp up output in order to take advantage of those higher values and profit margins. The high prices leading up to 2011 allowed producers to mine and explore for higher cost production, which caused market oversupplies across many commodity markets. As prices turned south, this high cost production became uneconomic leaving markets with gluts that weigh on price. Decreasing demand across the world and a strong dollar just made a bad situation worse.

The Russians are not the only ones suffering during the current raw material bear market. Other commodity producing nations like Brazil, Australia and Canada all experienced economic difficulties associated with falling commodity revenues.

As a major producer of oil, metals and minerals, the Russians have limited options as prices fall. For example, in order to keep oil revenues the same as they were in 2011, the Russians would need to sell more than double the number of barrels that they sold during those heady times. This is the case for many of the commodities that Russia produces.

The Russian ruble has plunged in value because of a combination of sanctions and lower commodity prices. As the nation sells more commodity output in exchange for lower revenue, they add to their economic woes in what has become a vicious circle of losses and lower cash flow.

 It is likely that the Russian economy will continue to suffer until commodity prices bottom and turn higher. Commodity markets are cyclical, and eventually commodity rich Russia will emerge from their present economic situation. The Russian economy is highly correlated with the price of commodities.