The drop in oil prices by 24% to about $35 a barrel was the single biggest one-day drop in oil prices since the beginning of the Gulf War in 1991. The drop in oil prices also triggered a steep sell-off in markets. The Dow Jones Industrial Average fell more than 2,000 points, and the S&P 500 fell 7%, reportedly the biggest decline since the financial crisis of 2008. 

The decrease in oil prices comes as the global economy is reckoning with the coronavirus pandemic, which has added uncertainty to markets around the world. 

What happened?

Oil prices, like all things,  are dictated by supply and demand. When supply falls, prices rise, and vice versa. 

As the world economy has slowed because of coronavirus, the Organization of the Petroleum Exporting Countries (OPEC), a group of the world’s biggest oil producers that includes Saudi Arabia, has wanted to offset the decline in demand by cutting oil production. When OPEC members cut production, that typically increases the price of oil by limiting supply. When it increases production, that typically causes prices to fall. 

However, Russia, which isn’t a member of OPEC but has had a working pact with the group since 2017, decided not to go along with the group. In response, Saudi Arabia, the biggest oil producer in the world, announced it would increase production and cut prices between $4 and $7 a barrel. The move, according to some reports, could allow Saudi Arabia to take market share away from Russia. 

And when prices fall by a large amount, it can slow down production of oil and gas. Higher oil prices, generally, make it more cost-effective for oil companies to extract and process oil.

On the plus side, however, lower oil prices mean cheaper gas for consumers. Gas could fall below $2 a gallon, according to some estimates.

More about OPEC

OPEC members, comprising Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, United Arab Emirates, and Venezuela, among others, control about 80% of the world’s oil reserves, according to the organization. It was founded in 1960 to set production levels among member countries. 

Follow the Stash Way

We’ve boiled down our investing philosophy into three basic steps that we call the Stash Way. It involves investing for the long-term, investing regularly, and diversification. 

You can find out more about that here.

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The accord, which waived economic sanctions on Iran in exchange for a halt to its nuclear weapons program, was originally put into place by the Obama administration in 2015.

Under the deal, Iran agreed to concessions, most notably reducing its uranium stockpile, and allowing inspectors from the International Atomic Energy Agency to monitor its declared nuclear sites.

Trump, however, has decided to reverse course and withdraw the U.S. from the agreement, while also reinstating sanctions on Iran.

What’s a sanction?

A sanction is a type of penalty, typically levied by one nation or group of nations on another in an effort to deter or punish certain behavior.

In this case, Iran was sanctioned by the U.S. for attempting to build a nuclear weapon. Those economic sanctions–which are commercial or financial in nature–were meant to put pressure on the Iranian government by hurting the country’s economy through blocked trade and transactions.

In pulling out of the nuclear pact, Trump announced that the U.S. will reinstate sanctions previously lifted under the deal.

American allies, including leaders from France, the U.K., and Germany, unsuccessfully tried to pressure Trump into recertifying the deal.

Why is Trump pulling out of the deal?

There isn’t a clear answer, though Trump has said that he wants an agreement that sticks tougher restraints on Iran, including limits on its nuclear fuel production. He also opposes the current deal’s sunset provision, which allows Iran to resume its nuclear program after 2030.

Trump has called the accord, in its current form, the “worst deal” and “an embarrassment.”

Trump has also claimed that Iran was cheating or not sticking to the terms of the deal; A claim to which he has provided no evidence, and that his own intelligence agencies have refuted.

The immediate fallout

The immediate effects of Trump’s decision are that American allies–notably countries in the European Union–will be alienated, and strain already tense relationships.

“France, Germany, and the UK regret the U.S. decision to leave the JCPOA,” French President Emmanuel Macron tweeted following Trump’s announcement. “The nuclear non-proliferation regime is at stake.”

Iran, taking America’s cue, could also decide to violate the terms of the deal and ramp up nuclear activities.

Iranian leaders have, however, said they’re willing to continue working within the accord’s framework with its co-signers for the time being.

Business and the economy

There are also many business dealings–between both American and European companies–in the works involving Iran. Boeing, for example, could lose $20 billion in aircraft sales to Iran as a result of Trump’s decision. General Electric, also, had deals in place to supply Iran’s oil and gas sector with equipment, which could now be threatened.

Another company, Volkswagen, returned to Iran after 17 years once the nuclear deal was signed and sanctions were lifted. Now that the deal is off, it may need to once again pull out of the country.

French aerospace company Airbus, like Boeing, may also need to scuttle its plans to sell planes in IranAir, Iran’s national carrier.

As the reinstatement of sanctions all but puts a stop to those deals and more, it could also create stock market volatility and have other economic effects.

Trump’s decision also increases the possibility of military action in the future–assuming Iran resumes work toward building a nuclear weapon.

What you should prepare for

For the average American,  the single biggest–or at least most noticeable–consequence of Trump’s decision is likely to be rising fuel prices.

Gas prices have already been on the rise over the past year, and reinstating economic sanctions on Iran, the world’s fifth-largest oil producer, could result in higher prices at the pump.

The terms of the nuclear deal allowed Iran to export oil to other countries. But with sanctions reinstated, it will no longer be able to export, and as a result, the global oil supply will get smaller. Lower supply can lead to higher gas and home heating prices.

Aside from costlier commodities, your portfolio could also be in for a wild ride as the markets react.

For example, the markets dropped considerably after Trump announced tariffs on Chinese goods, stoking fears of a trade war. The markets could act similarly regarding Iran.

There’s also a strong possibility that defense and aerospace stocks could rise or drop if the U.S. considers military action. The same could be true for domestic oil companies if world oil supplies shrink.

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Commodities are the stuff of life. They’re also one of the building blocks of the economy, and they’re as old as time. They’re things like gold, steel, aluminum, oil and even food. Pork bellies and cattle, live and turned into beef. They’re also the unleaded gas in your car. The corn and sugar in your pantry.

All of these things are commodities. They’re all valuable, and that’s why people invest in them.

What are commodities?

Unlike some of the more esoteric elements of the economy, commodities are rooted in reality. They’re heavy, they fill up pallets, and sometimes they even smell and make noise. They’re more tangible than currency, and they’re certainly more earthy than that flashy new stuff called cryptocurrency. And they’re easier to understand.

Commodities are useful. People were trading in gold and wheat thousands of years ago. Why? Their value is undeniable. Gold is generally considered the safe haven for investment, because everyone has always recognized its value.

How are commodities traded?

Commodities are divided into several categories, including energy, metals, agriculture, meat and consumer goods. Energy includes oil and gasoline, both natural and unleaded. Metals include gold, silver, platinum and copper. Agriculture includes corn, soybeans and wheat. Meat includes hogs and live cattle. Consumer goods include cocoa, coffee, cotton and sugar.

Commodities are divided into several categories, including energy, metals, agriculture, meat and consumer goods.

In the U.S. the two largest commodity exchanges are in New York (of course, think Wall Street) and Chicago (which makes sense, considering the stockyards of “The Jungle,” by Upton Sinclair.) They are called the New York Mercantile Exchange, the NYMEX and the Chicago Mercantile Exchange, CME.

Why do people invest in commodities?

Here’s something else, to keep in mind: Commodities can act as hedge against inflation, according to some experts, since they tend to increase in value as inflation rises.

Inflation can have a negative impact on  other stocks. And as we wrote recently, fears about inflation have sparked some of the current market turmoil. So commodities can potentially work as a stabilizing position in a portfolio when other equities are particularly volatile.

How do people invest in commodities?

There are three primary ways to invest in commodities

You can buy the actual raw product. Cowboys still run cattle drives into Fort Worth, Texas and miners still extract gold from the depths of South Africa. But if you don’t feel like buying a ton of zinc on a pallet and trying to figure out how to unload it, there are other ways.

Some investors put their money in commodity futures. They may try to predict what will happen to the price of bacon a month or two down the road.

Others might invest in exchange-traded funds, also known as ETFs. They’re perhaps the most user-friendly tools for investors, since they act as baskets of commodities (such as pork bellies) which are traded as units on the market.

What are the risks?

Commodities can still be subject to volatility, caused by natural shortages, or even political uncertainty. President Trump and the U.S. Department of Commerce unveiled a blueprint recently that would impose a 24% tariff on all steel imports, and even steeper tariffs of 53% on steel imports from a dozen countries. This could spark fresh price swings in commodities markets.

Explain it to me: What’s a tariff?

Oil is also notoriously volatile, experiencing the worst spikes during its long history in 1979, when the unstable political situation in Iran disrupted the flow of petroleum, followed by an even worse spike in 1980 with the Iran-Iraq war. Oil prices spiked once again to their biggest peak ever in 2008, when hit $100 a barrel for the first time, due to a regional crisis.

Even something as simple as corn can be the plaything of the environment and politics. Remember when biofuels like ethanol were going to change the world? That was also in 2008, when corn prices spiked so dramatically from the ethanol boom that was blamed for driving up food prices in general.

Back in October, the CME Group in October started including the trading of bitcoin futures in its exchange. Is cryptocurrency the new commodity?

Not yet. The thing about commodities is that they’re rooted in the real world. And for investors looking to diversify, they can potentially have a place in your portfolio that can hedge against inflation and rising interest rates.

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