Commodities and inflation: what history does and does not show

What you will learn

• Why commodities can be both a cause of inflation and a partial hedge against it
• The difference between expected and unexpected inflation for an investor
• How to convert a nominal commodity price into a real price
• What the 1970s, the 1980s–1990s and 2021–2022 do and do not prove

Explanation

The courses "Macro and Markets" and "Gold" explain how inflation is measured and how gold relates to it. This lesson looks at the whole commodity complex.

Two directions

Commodities as a cause: energy and food are part of the consumer price index (CPI). When they rise, inflation rises directly, and indirectly through transport and production costs. Commodities as a hedge: if prices in the shops rise because commodity prices rose, owning commodities offsets part of the loss of purchasing power.

A hedge here means an asset whose value tends to rise when the risk you worry about occurs. It does not mean a guaranteed offset.

Expected versus unexpected inflation

Markets already price expected inflation. Bonds and commodity futures prices adjust in advance. What hurts a portfolio is an inflation surprise: inflation higher than expected. Commodity prices have often reacted to surprises, especially when the surprise was itself caused by a commodity supply shock. This is why "buy commodities after inflation figures are high" usually comes too late.

Nominal and real prices

A nominal price is the price in money of the day. A real price removes general inflation:

Real price (in base-year money) = nominal price × CPI base year ÷ CPI current year

Over long periods many commodity prices rose much less in real terms than in nominal terms, because technology and new supply lowered production costs. A long-term chart in nominal prices therefore exaggerates how well commodities "kept up".

What history shows

• 1970s: the oil price roughly quadrupled during the 1973–74 oil embargo and rose again in 1979–80. Commodity prices and inflation rose together. Here commodities were a cause of inflation, which is why they also worked as a hedge.
• 1980s–1990s: inflation fell, and real prices of many commodities fell too. The oil price collapsed in 1986. A commodity holder in this period had no inflation to hedge and weak returns.
• 2000s: a long commodity boom, driven to a large extent by demand growth in emerging economies, while euro-area inflation stayed moderate. Commodity prices rose without high inflation.
• 2021–2022: energy prices spiked, and German consumer price inflation reached its highest level in decades, with energy as a main driver according to the Federal Statistical Office (Destatis). Energy prices later fell back while services inflation stayed high for longer.

Academic research, for example Gorton and Rouwenhorst's 2006 study "Facts and Fantasies about Commodity Futures", found that commodity futures returns were positively correlated with inflation in historical US data. This is a historical observation, not a promise about the future.

Practical conclusions

• The link is strongest when inflation comes from commodity supply shocks, and weak when it comes from wages and services.
• Futures-based products also earn collateral interest, which tends to rise when central banks raise rates against inflation. Roll yield can work against you (lesson 7).
• Commodity returns are volatile. A small allocation can be a diversifier; a large one adds its own large risk.

Worked example

Hypothetical example, part 1: CPI contribution. A simplified CPI has these weights: energy 10%, food 12%, everything else 78%. Over a year, energy prices rise 30%, food 10%, everything else 3%.

1. Energy contribution: 10% × 30% = 3.00 percentage points.
2. Food contribution: 12% × 10% = 1.20 percentage points.
3. Other: 78% × 3% = 2.34 percentage points.
4. Total inflation: 3.00 + 1.20 + 2.34 = 6.54%. Energy and food make up 22% of the basket but contribute 4.20 of the 6.54 points, about 64% of the total.

Part 2: real price. Wheat costs €150 per tonne in a base year (CPI 80) and €240 twenty years later (CPI 120).

1. Nominal change: 240 ÷ 150 − 1 = +60%.
2. Real price in base-year euros: €240 × 80 ÷ 120 = €160.
3. Real change: 160 ÷ 150 − 1 = +6.7% over twenty years.

The nominal chart suggests a strong gain; in real terms the price barely moved. Storage, roll and fees are excluded.

Common mistake

Practice activity

Simplified CPI weights: energy 8%, food 14%, other 78%. In one year energy falls 10%, food rises 6%, other rises 4%.

Tasks: (1) Calculate total inflation. (2) A commodity index product returned +2% nominal that year. Calculate its real return. (3) Was the product a good inflation hedge in this year? Explain in one sentence.

Limitations: Real CPI baskets have many more categories, and weights change over time; the method, not the numbers, is the point.

Key takeaways

• Commodities hedge inflation best when commodity supply shocks are the cause of the inflation.
• Only unexpected inflation matters for returns; expected inflation is already in prices.
• Always compare real, not nominal, commodity prices over long periods.
• History shows episodes in both directions; it does not promise a future relationship.

Next step

In lesson 11 you look more closely at supply shocks themselves: sanctions, wars and disruptions of trade routes.