The ChoosaBroker Trading Academy
7.7. Factors That Affect Commodity Prices
Taking trading volumes into account, the commodities market is the second biggest financial market in the world. And given its massive size, it sometimes becomes difficult to ascertain the exact factors that influence the value of commodities. In this lesson, we will try to learn about the four fundamental factors that have seemingly had the maximum impact on commodity prices since the turn of the century. It is important for traders and investors to note that the importance of each one of these factors varies from individual commodity to commodity, and from market cycle to market cycle. A number of the leading online brokers offer options for commodities trading.
Technological innovations can be a game changer for commodity prices. Macroeconomists often wrongly assume that such innovations are largely driven by exogenous forces, unrelated to markets. But most commodity production, distribution and consumption innovations are directly impacted by prices and vice-versa. When commodities become scarce, prices rise. This increase, in turn, stimulates innovation and adoption of new techniques and technologies to make the market more efficient. Contrarily, when commodities become abundant, prices decline and the pace of innovation and adoption of new technologies slows.
Let us take the example of crude oil. A decade ago we were all being told that peak oil output levels had been reached, and that declining stocks would mean astronomically high prices in the future. Yet, at the time of writing, Brent crude futures are trading at $70 a barrel – over 50% below its peak price. So what happened? Technology happened, that’s what. Breakthroughs such as hydraulic fracking and horizontal drilling meant that oil previously trapped within shale formations could be extracted. This boosted supply of the commodity and pushed prices lower.
There exists a fairly broad consensus that, in the longer-run, high material living standards and better environmental quality are mutually consistent, if not interdependent goals. However, at least in the medium- to short-term, environmental regulation and economic growth are typically viewed as competing aims. An increase in economic activity, supported by greater commodity production and consumption, is inevitably labelled as being bad for the environment. While, on the other hand, environmental protection policies are considered a drag on growth.
The recent pollution crackdown in China is a glaring example of how environmental regulations can affect commodity supply and prices. In August 2017, the Chinese central government unveiled a policy to control air pollution during the winter months in Beijing, Tianjin and 26 other cities in the smog-prone provinces of Hebei, Henan, Shanxi, and Shandong. Known as the “2+26” policy, it imposed strict production curbs on polluting industries, including a large number of steel plants, stifling supply of the alloy.
The present century will record the largest population growth in the history of humankind. The United Nations estimates that the world will add roughly 1 billion people during each of the first 5 decades of the 21st century. So how is this linked to commodity prices? Simply put, rapid increase in population will translate to greater global demand for commodities. As the number of people in the world rise, so will the demand for these naturally-occurring, finite resources. After all, people will always need food to eat, houses for shelter, and heat to stay warm during winters. Barring short-term supply spikes, this projected significant population growth will drive demand for commodities, putting secular upward pressure on prices.
Demand From Emerging Economies
According to figures from the World Bank, emerging economies like China and India have become the main sources of commodity demand growth since 2000. As a result, any weakening of their economic growth prospects curb global demand and weigh on commodity prices. The growing clout of emerging economies is represented by the fact that from 2010 to 2014, Brazil, Russia, India, China and South Africa (BRICS) accounted for roughly 40% of global primary energy and food consumption, and close to 50% of global metals consumption. An extended slowdown in these countries will not only hurt prices, but also derail economic growth in the net commodity exporting countries.
As with most other financial securities, retail traders and investors are an integral part of the commodities speculation market. Their success in the market depends primarily on their ability to correctly analyze various current events to forecast future demand and supply levels. Keeping track of changes in the above four key determinants can be a good starting point.