Commodity market

Commodities markets are the main markets of interest for big companies when treating commodities as raw materials such as oil and gold


Rule of thumb



In reality, most individual investors are not interested in the underlying asset traded with futures, but in the potential profits available from these contracts

This is why more and more transactions are handled as “Over-The-Counter” or OTC with such brokers as us, using the financial instruments Contract for Differences (CFDs)

Trading using CFDs and other derivative instruments typically allows one to participate in the market movement of a given commodity, without the necessity to deal with the physical goods with all their consequences

Commodities are extremely important not only to the general economy, but also to companies and individuals. Commodities are essential as raw materials in order to produce goods. If commodities

or these raw materials are not available or expensive, the final products will also be significantly expensive for the consumer. The range of commodities available is very wide, from wheat, cattle to oil or gold.

The trading on some commodities concentrates mainly in the countries where they are produced. An example may be orange juice, which is a commodity that has been traded in the United States for decades, while other countries simply import and consume this commodity.

Commodities are traded on exchanges, the most popular being the Chicago Mercantile Exchange (CME) and New York Mercantile Exchange (NYMEX). In these exchanges, commodities are traded via futures contracts, which obligate both sides to finalise a transaction on a previously specified date, price and other conditions.


Prices presented in media services or news services are usually the contract futures prices traded on exchanges, which in turn are based on the supply and demand of the commodity.

The historical reason to use futures contracts is very prosaic and results from the obvious reasons that commodities may not be delivered “instantly” as other financial instruments. Therefore, in order that both sides secure the value of the transaction from the volatility that may occur until the delivery, future contracts are used.

There are many factors that could be taken into consideration by an astute trader following the fundamental outlook of the commodity markets. Everyday in the media some information can be found that may significantly impact the demand or supply side of the given commodity, affecting the price in the short or possibly even long term. Which events or circumstances may be of importance for the analysis of the commodity market?

Here is our checklist of the key factors, along with the guidelines for their interpretation:

  • natural resources
  • extraction possibilities/technology
  • evolution
  • legal acts
  • weather conditions
  • political conditions
  • economic recession
  • economic growth
  • confidence
  • events
  • experts opinions

THE KEY FACTORS OF THE COMMODITY MARKET

Political situation

This is a factor that is having an increasing impact on the prices of commodities. Not only because more traders are present in the commodities markets, but also more countries are now affected by political decisions than decades ago. One of the most popular examples of how a political situation affects prices is war. The war between Iraq and the United States, that began in March 2003, resulted in a rise in oil prices on a constant basis. This is because of different reasons. One may be the fact that countries involved have an increased need for oil in order to mobilise military units. Probably the most important reason in this case though, is the fact that Iraq and other countries surrounding are very significant oil producers. Traders around the world do not know what the real political determinations of countries engaged in the war are, so they assume temporarily that the oil supply will be limited, increasing in turn the price of oil. This commodity is especially significant to US consumers as imported oil accounts for 60% of US consumption.

Economic recession

Economic recession may be related to a lower demand for goods, which in turn reduces production. This may be understood as a surplus of supply in relation to demand at the previous price level, which results in a price decrease of commodities. On the other hand, there are commodities that are positively correlated with the recession level. That is, the bigger the recession, the more prices will soar. Perfect examples of this situation is Gold or other precious metals. During moments of economic recession, investors tend to withdraw money from capital markets investing in precious metals, which are considered to be relatively safe investments in such circumstances. On the other hand, in moments of high economic activity and optimism in relation to its future growth, prices of precious metals tend to be lower.

One time events

There are also situations which have a temporary effect on commodity prices. One may think of the Olympic games that occurs every 4 years, and even more rarely in the same country. This type of event requires big investments which also attracts foreign capital, but also more raw material are necessary in that country. This situation may be considered as a temporary increased demand for certain items in that country. Also during the time of the events, there is an increased demand for other commodities, like cattle because of the increased number of visitors to that country. Strikes may also be good examples of how events have significant effects on commodity prices. A strike in a gold mine in Peru (2010) causes the prices of gold to spike. Of course, strikes may not happen very often, but this makes their influence even greater.

Confidence

This element is becoming a more important agent which has an influence on the prices of every financial instrument, independently if it is a commodity, currency or bonds. Usually confidence levels “move” similarly to economic cycles - some studies even find that confidence levels precede the actual economic cycles. Sometimes, even if economic growth is observable, confidence is not necessarily as high as one would expect. Confidence may be affected by internal political decisions that do not necessarily have an influence on the economy, but raises questions for investors.

Weather conditions

The weather may have very important consequences on the prices of commodities. Harsh weather may result in a small production of commodities like wheat or barley, which typically leads to a price increase of these commodities. Examples of weather conditions that occur cyclically, which have an impact on prices, is the summer’s hurricane period in the Mexican Bay, south of the United States, when hurricanes may hurt the production of agriculture related commodities such as wheat or even cattle.

Experts opinions

For other markets, like the foreign exchange market, the opinions of people closely related to monetary policy are considered to be interventions. On the commodities markets, there may not be interventions, but investors also follow the opinions of other experts. An example could be opinions expressed during/after the OPEC (Organisation of the Petroleum Exporting Countries) meetings, or the Davos summits (World Economic Forum).

Natural resources

Many commodities are by nature limited to some geographic locations. For example gold or oil may not be available in every country, which makes these commodities more price sensible than others, especially in relation to the situation in given regions.

Extraction possibilities/technology

Depending on the given commodity, different technologies may apply. News relating to development of the technology of production may have quite a significant effect on prices of commodities. The introduction of new technology may require very high initial capital, but in the long term makes prices lower increasing the margin for companies.

Economic growth

Although, prices of precious metals tend to be lower during economic growth, the prices of other commodities may rise. Such commodities as wheat, or others, have an increased demand during economic growth, which generates inflationary pressure.

Legal acts

Again this factor may be somewhat related to the evolution factor. Environmental legal pacts binding countries to limit the emission of CO2 in the world, have been one of the most important reasons to create contracts on CO2 emissions, which in turn can be bought and sold on the international market.

Evolution and global climate changes

This is an interesting long term factor that may not have a direct effect on current commodity prices, but gives the opportunity to create new commodities like contracts on CO2 emissions.