Commodity prices: Here are 4 factors that determine whether they rise or fall

Commodity prices are amongst the most volatile asset prices in the financial markets – even more than stocks and bonds. In fact, they influence the prices of stocks, bonds and other financial assets as well as economic activity generally.

But what are the factors that cause commodity prices to move?

 

Supply and demand

First and foremost, supply and demand is the primary factor that influences the price of commodities. If there is an oversupply in the market then prices are driven down as buyers have plenty of options to choose from, however if there is a shortage then prices will rise as the available commodity becomes more valuable due to its scarcity. All other factors influencing commodity prices are just influencers of the supply and demand mechanism.

There’s no better example than the current bear market for battery metals such as nickel and lithium. EV sales are growing at a slower pace than a couple of years ago, all while lithium mines are being ramped up at the same pace they were a couple of years ago.

Conversely, uranium prices are at 15-year highs because the demand for uranium is growing, given their potential role in decarbonisation. For the record, the current bull run was long before Opposition Leader Peter Dutton’s plans for uranium in Australia. Other jurisdictions, particularly the US have long been considering it, and many companies (such as Paladin Energy and Boss Energy) are re-opening mothballed mines.

 

Economic growth

Second on our list is Economic growth. As economies expand or contract, so too do the needs and wants of consumers, thus affecting the amount of available goods and services they can purchase. When economic growth is healthy it helps boost commodity prices since people have more disposable income to spend on them.

Conversely, during times of an economic recession or stagnation commodities may become significantly cheaper as fewer people can afford them. Many commodity prices fell during the GFC in conjunction with economic activity.

 

Inflation

Inflation can also cause commodity price fluctuations. Generally speaking when inflation rises so do the costs associated with producing those goods which leads to higher consumer prices for those products. On the other hand deflation can lead to lower consumer prices as producers reduce their margins in order to remain competitive.

 

Geopolitics

Finally geopolitical events such as wars or natural disasters also play an important role.

For example, during times of conflict certain commodities such as oil may become scarce due to disruptions in production or transportation leading to higher consumer costs for those goods.

Similarly, following natural disasters like hurricanes or earthquakes certain commodities may not be readily available causing their respective markets to experience spikes in price due to limited supply created by these events.

One of the best examples where this is so is oil where the nations forming OPEC agree to either increase or decrease production. This can occur as a matter of routine at OPEC’s regular meetings, or sometimes in response to geopolitics. In the early 1970s, oil prices spiked when they cut the supply of oil in retaliation for Israel’s actions in the Arab-Israeli war of 1973.

 

So how can commodity prices influence stocks?

Commodity prices can have a significant influence on stocks because they are a key part of many companies’ business models.

For example, industries such as agriculture, mining, and energy are heavily reliant on the prices of commodities to ensure their profitability. If the price of a commodity rises or falls drastically, it can result in huge losses for companies that rely on them as part of their operations. This can lead to decreased profits, which in turn could affect the stock price of the related company or industry. In addition, stock market investors often pay close attention to changes in commodity prices when making decisions about where to invest their money.

When the prices of commodities rise, investors may feel more confident that companies linked to those commodities will experience higher profits and be more likely to invest in them.

Conversely, if they fall rapidly it may make investors hesitant to commit their resources because they fear lower profits and potential losses. By investors, we also mean companies – just look at how all the uranium stocks mothballed their projects when prices collapsed following the GFC and the Fukashima nuclear disaster.

What’s more, this influence is not limited solely to companies directly involved with those commodities — if one industry experiences an upswing or downturn due to changing commodity prices, it can create a ripple effect throughout other industries as well.

Consequently, changes in one sector caused by fluctuating prices can have far-reaching consequences for many different sectors of the economy and the stock market at large.

 

Watch them closely

Commodity prices need to be watched closely by all investors. And we are not just talking about the specific commodity your stock has exposure to. This is because they can influence the prices of individual companies as well as the direction of entire industries and even the broader economy.

 

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