Commodities explained

Commodities, such as oil, wheat, or copper, are raw materials traded in markets all around the world. These resources are essential inputs to many industries and their prices are determined by supply and demand. 

Prices will rise when demand exceeds supply and fall when supply exceeds demand. This is not rocket science…

The million-dollar question is what factors can impact supply and demand? The answer is not that obvious because there is actually a great variety of dynamics that can interfere with sourcing and need, like weather patterns, demographic shifts, technological innovation, geopolitical risks, or reckless comments from policymakers or unreliable tweets from suspicious informants.

Lets focus on the main drivers:

Weather patterns

These are critical if you trade on agricultural commodities since they play a crucial role in determining supply. Droughts, floods, and other extreme weather events can disrupt crop production, leading to shortages in supply and consequently higher prices.

For instance, since the beginning of 2023, sugar is in a bullish trend, and in April prices hit record highs. Analysts say this trend will hold in the short to medium term, given weather risks plaguing top producers. The Asian cane crushing season has started to wind down with large downward crop revisions in the key producing countries most notably India, Thailand, China and Pakistan.

Demographic shifts and technological innovations 

They can impact demand whenever they leverage economic growth, on a B2B or in a B2C perspective.

For instance, the rapid growth of the middle class in emerging markets like China and India has led to increased demand for commodities like oil, copper, and steel, as these countries invest in infrastructure and urbanization. Technological innovations in the energy sector, such as the rise of renewable energy sources, have also created new sources of demand for commodities like lithium, cobalt, and nickel.

Geopolitical risks

Recently, we became to understand better the impact of those risks as Russia invaded Ukraine. But all around the world, political instability, conflicts, and sanctions can have a significant impact on commodity markets, particularly in regions that are major producers or consumers of these resources. 

The article I wrote last week gives a clear example of how such risks interfere with a commodity as important as crude oil.

Macroeconomic trends

These are the key factors that matter most at the moment: monetary policy, inflation, and exchange rates. Such macroeconomic variables affect currencies' value - especially the USD, the main currency used for trade - therefore impact the cost of commodities.

The relationship between the value of the USD and the price of commodities is complex and multifaceted, with various factors influencing the correlation between these two variables. 

The price of commodities is generally denominated in USD, which means that when the value of the USD increases relative to other currencies, it becomes more expensive for other countries to purchase commodities. In such situation, demand can collapse putting a downward pressure over prices.

Conversely, when the value of the USD decreases, commodities become more affordable, increasing demand and potentially driving up prices.

In an economy with no inflation, commodities are seen as a hedge against inflation, as they tend to hold their value better than currency. As a result, when inflation rises, commodity prices may increase.

But what’s happening currently is that the FED is using rising interest rates as an instrument to lower inflation and such monetary policy is strengthening the USD. That being said, whenever interest rates rise investors are attracted to higher yields and that increases the demand for USD.

The parallel between USD valuation and commodities price is not always a straight line given the interference of other factors that lead to price fluctuation.

The interconnectedness of global markets and the complexity of the factors that drive commodity prices can make it difficult to predict price movements.

Predicting the future of commodities prices is a complex task, as it involves a variety of circumstances that can shift rapidly and unpredictably. However, based on historical trends and current events, we can make some educated guesses. Nonetheless, it is always important to monitor the markets and stay informed about the latest developments in order to make informed decisions.

If you want to start trading I don't honestly think this is the right time to begin with commodities given the volatility and complexity of factors you have to consider for an accurate fundamental anaylizis.

Disclaimer: The information contained in this article in not investment advise.