Lesson 4: Factors Affecting Commodity Prices

Factors Affecting Commodity Prices

Factors Affecting Commodity PricesIt continues the Commodity Course. Last week we saw what the main kinds of commodities traded in the financial markets are. Now, we see what the different factors affecting commodity prices are.

Supply and Demand. The supply/demand relationship determines the price of exchange of goods and services. The price of various commodities reflects exactly this law of the market.

If the supply increase, but demand does not change, (think, for example, the harvest of corn that has a higher than expected return and, then, with a larger amount of corn in the market), the price will tend to fall. Many farmers will be willing to undercut the price of their corn to try to find a buyer.

If the demand will grow, but the producers will not be able to satisfy it (think to an epidemic affecting the cattle resulting in a sharp decrease of meat on the market), then the price will increase because buyers will be willing to pay a higher price for the amount of product needed.

The Weather. It can influence the price of commodities and affect a lot the production. It is, in fact, often the only responsible for very strong price movements due to imbalances in the supply/demand relationship.

Adverse weather conditions do not affect only the crops such as wheat or coffee, but all the commodities. Just think about the price of oil after the passage of Hurricane Katrina or to transportation blocked due to heavy snowfall and frost.

Diseases and epidemic. Some external factors can the price of a commodity skyrocket, such as diseases of a crop or an epidemic that affects the livestock. Like for the adverse weather conditions, diseases and epidemic create imbalances in the supply/demand relationship because of a reduction in supply and, as a consequence, we have a strong movement in prices.

The reason is that buyers predict that the future availability of a commodity could become scarce, thus they increase the demand for that commodity. They are willing to pay it more today than in the future.

Economic and political factors. Prices of commodities are also affected by the economic and political events of the countries that are producing or using that commodity. For example, political unrest in the Middle East often causes the futures price of oil to fluctuate due to uncertainties on the supply side.

Think, also, to a strike in the gold mines in South Africa, or the duties in some South American countries on exports of grains. So, political and economic stability or not of a country can influence the price of a commodity.

Reports. They are very important and give us a picture of the situation of commodities in their various phases: production, cultivation, demand, supply, etc. Just a change in the size of land cultivated can rise or drop a lot the price of a crop.

The inventories and stocks showed by the reports affect a lot the price of a commodity. Like, for example, the Weekly Petroleum Status report that every Wednesday is released by the by the EIA (US Energy Information Administration) providing about the petroleum supply situation. The new inventories can influence the crude oil price strongly.

U.S. Dollar. Commodities are priced in dollars so, the US dollar is their enemy. A rising dollar is anti-inflationary, so it applies downward pressure on commodity prices. Similarly, a falling dollar will usually apply upward pressure on commodity prices.

Investing in commodities is a lot different from investing in stocks and other financial assets. With commodities, we are typically dealing a physical good, and managing that physical good takes effort that stock investors do not have to worry about.

Another aspect that you can deduct from the list above, it is that the commodity market can be lesser manipulable than the other financial markets because the price is affected by the weather, diseases, epidemic, political factors, etc. that cannot be manipulated.

In next article, we will see how to invest in commodities.

Seasonalgo, seasonal trading, spread trading, commodity market


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