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What drives commodity prices?

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Every commodity has unique factors that affect its price.

However, overall, the major driver of commodity prices is supply and demand. Higher demand for a commodity pushes its prices up, while excess supply of a commodity pushes its price down.

Supply and demand can be impacted by many different factors.

Here’s a look at some of the main factors.

Demand

Key drivers of commodity demand include:

1. The health of the global economy:

During periods of strong economic growth, demand for many commodities tends to be high due to the fact there is more construction and manufacturing activity. Conversely, during periods of weak economic growth, commodity demand tends to be lower due to the fact there is less construction and manufacturing activity.

2. Growth in the emerging markets:

Fast-growing emerging market countries such as China and India are a major source of commodity demand. These countries need commodities to build infrastructure, fuel their factories, and feed their growing populations. During periods of economic expansion in the emerging markets, demand for commodities tends to be high.

3. Consumer trends:

Consumer trends also play a key role in commodity demand. For example, consumer demand for jewellery can boost demand for gold. Similarly, demand for cars can have an impact on the demand for platinum, as this is used to make catalytic converters, which help to reduce vehicle emissions.

4. Manufacturing trends:

Demand can be impacted negatively by commodity substitution. If a particular commodity becomes too expensive, buyers will look for cheaper alternatives. A good example here is copper, which is used in a wide range of industrial applications. As the price of copper has risen, many manufacturers have used aluminum as a substitute.

5. The strength of the US dollar:

Most commodities are priced in US dollars. When the US dollar falls, it means commodities are less expensive in other currencies which can lead to an increase in demand. Historically, the prices of commodities have tended to rise when the value of the US dollar has weakened against other major currencies. This inverse relationship does not hold all of the time, however.

Commodity demand example

When the Covid-19 pandemic sent the world into lockdown mode in early 2020, the global travel industry ground to a halt. As a result, demand for oil – a key ingredient in gasoline and aviation fuel – plummeted. This resulted in a spectacular collapse in the price of oil.

Supply

Key drivers of commodity supply include:

1. Government intervention:

Governments can play a key role in commodity supply by introducing production constraints. For example, the Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental oil organisation, has been known to enforce supply cuts in the oil market in order to bolster oil prices.

2. Geopolitical events:

Conflicts between countries, terrorist attacks, trade wars, social unrest, and closures of important transport routes can all impact commodity supply.

3. Weather:

The weather can also play a major role in the supply of agricultural commodities such as sugar, cotton, and cocoa. These kinds of commodities require consistent weather cycles for farmers to grow crops.

Commodity supply example

On 14 September 2019, a swarm of explosive drones attacked Saudi Arabia’s Saudi Aramco oil processing facilities. The drone attack caused large fires at the facilities which ultimately cut Saudi Arabia’s oil production by about half – representing about 5% of global oil production – temporarily. This sudden decrease in oil supply caused oil prices to surge higher.

Reprinted from eTorothe copyright all reserved by the original author.


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