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What Are the Main Drivers of Commodity Prices?
The commodity market, like other market sectors, experiences volatility and is heavily impacted by multiple factors. Accordingly, in this article, we’ll look into what affects this market sector and the things to look out for when trading commodities. Over the past few decades, the growth in the global economy has also spurred the growth of the commodity market. With financial markets becoming more accessible, many traders have turned to the commodity markets to look for new trading opportunities. The commodity market tends to experience high volatility, which can have an effect on the trading strategies a trader employs. There are several factors behind the high volatility experienced by the commodity market; the key factors include the supply and demand of a commodity, currency movements, geopolitical situations, government policies and economic growth.
Supply and Demand
As the supply and demand for commodities change, the price of the commodity will also change. The fundamental rule is that commodity prices will rise with increasing demand. Prices will also rise when there is a fall in the overall supply or inventory of a commodity. On the flip side, the price of a commodity will fall when faced with decreasing demand and increasing supply.
For example, in 2020 with the emergence of the Coronavirus pandemic, the world was put on hold as a global wave of lockdowns kept people home. With the shift to a home-stay the demand for gasoline sank, and as a result, the prices of oil tumbled. At some point, the price of WTI stooped as low as $18 a barrel on April 20th of 2020.
Commodities are generally priced in USD. As the wider value of the USD rises and falls, so can the price of commodities. For example, if the USD experiences a sharp rise against a basket of major currencies, as expressed in the commodities, this could see a fall in the prices of commodities such as Crude Oil, as well as other Energy, Precious Metals and Agricultural products. It is, therefore, prudent to keep your eyes on the forex market as well when trying to understand the broader commodities market. Nonetheless, of course, markets do not always operate so uniformly. However, such external factors should be considered when trading. For example, the price of the US dollar affects commodities like Gold (XAU), in that since Gold is an asset that has intrinsic value, it's worth can ebb and flow and when the US dollar strengthens in relation to other currencies, gold prices tend to dwindle in dollar terms. Furthermore, it is said that commodity prices and inflation affect one another.
Some commodities are produced in regions that experience a great deal of political uncertainty. For example, crude oil is largely produced in countries around the Middle East. This means that the price of Brent and WTI can be heavily influenced by tensions that historically occur in that region. For example, when the USA imposes economic sanctions on Iran, the crude oil market generally trades higher due to the anticipated cut-off of the supply of Iranian crude oil to the market. Another distinct example for this is the war between Russia and Ukraine, which started in February of 2022. This war has clearly shocked the commodities’ market, and according to the World Bank’s Commodity Market Outlooks, it caused grave disruptions in the production of the commodities, especially those exported from Russia and Ukraine. Russia is considered one of the largest exporters for coal, Crude Oil, Natural Gas, Wheat, and Aluminum. Thus the geopolitical tensions both caused a physical destruction of the production of commodities on the post-Soviet soil and a disruption in the trade and exportation of commodities due to the sanctions on Russia.
The prosperity of a country can also affect the price of a commodity. This is because the economic prosperity of a country determines the purchasing power of its population. The effect is more obvious if the country in question is a major producing country or major user of that commodity. A good example is the case of Venezuela. Although a major oil country, the government has damaged the country's oil industry due to lack of investment, corruption and cash shortages. This, in turn, has crippled the economy and caused hyperinflation. Moreover, the economic sanctions imposed on Venezuela have further constrained oil production, exports and revenues in the country.
Mother Nature also has a decisive role to play in determining commodity prices, especially in the agricultural sector. Favourable weather may result in a bumper harvest leading to an oversupply of a commodity, whereas adverse weather can result in the destruction of a harvest, leading to a shortage in the supply of a commodity to the market. Adverse weather can also affect the price of heating oil and Natural Gas in the market. A cold spell can result in increased demand for energy products, which in turn pushes prices higher. For example, in April of 2021, Brazil, one of the biggest coffee and corn-producing countries, suffered a wave of droughts followed by frost. Needless to say, these unfavorable weather conditions, spiked the prices of coffee and corn supplies.
Transportation and Storage Costs
Although not usually a major factor, transportation cost can also play a part in moving commodity prices. For example, crude oil tankers sometimes double as storage facilities during times of oversupply. This action has the effect of taking available tankers out of the transportation market, resulting in higher shipping rates.
The Bottom Line
As shown above, there are many factors which play a part in determining the prices of commodities. Some of these factors, such as government policies, are predictable whereas some factors, like Mother Nature, are unpredictable. It is important to familiarize yourself with all the major factors such as those listed above so you will be better prepared when trading the commodity market. Trading in commodities is high-risk, so it is important to employ risk management strategies and choose a reliable and established provider such as Plus500 that operates professionally and under strict regulatory guidelines. Providers such as Plus500 offer commodity trading on an online platform in the form of contracts for difference (CFDs).
This article contains general information which doesn't take into account your personal circumstances.