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The price formation of any financial instrument on any market is subject to supply and demand. However, since commodities are natural resources and materials, the dependence of the commodity market on supply is much heavier than in any other market. In fact, the scarcity of these resources is exactly what makes them so valuable. Moreover, hard commodities like oil, gas or precious metals are not renewable, which only adds to their value.
Following the law of supply and demand, a deficit in supply and steady demand usually leads to increasing prices and vice versa. Here are some of the major factors that affect price movements in the commodity market and can signal potential trading opportunities:
Natural disasters
Since commodities are mined, extracted or grown, nature plays a significant role in these processes. A flood, drought or other severe weather conditions can disrupt the extraction. When it comes to soft commodities like wheat or corn, crops can simply be destroyed entirely. Moreover, unfavourable weather can also impact supply lines and make transportation and exports more difficult. Hence, whenever any of these events happen, it can reduce the supply drastically, and with the same level of demand in place, prices of affected commodities may start climbing.
Keep in mind that nature also plays a role in seasonality. For example, agricultural commodities are seasonal, and their prices tend to decrease during harvest due to the influx of new crops. Natural disasters affecting commodity supply, like hurricanes, in many parts of the world can also be seasonal.
Another seasonal trend to look out for is the US summer driving season. During warm months, people tend to travel more, increasing the demand for gasoline and driving the price of crude oil up.
On the other hand, during cold months, traders usually see an increase in other energy products, such as natural gas, as it's widely used for heating.
Geopolitical tensions
Any prolonged political or geopolitical unrest, whether its localised strikes, territory dispute or war, affects supply channels. The Russian invasion of Ukraine is one great example to demonstrate how it works. Both countries are in the league of the largest commodity suppliers – oil and gas on the Russian side and wheat and corn on the Ukrainian. Sanctions applied to Russia and blocked by war supply chains in Ukraine caused a lot of volatility in the commodity market.
Currency exchange rates
Fluctuations in currency exchange rates are usually caused by inflation, interest rates and other economic indicators. As most commodities are traded against the US dollar, they are dependent on its value. Compared to other currencies, the USD's appreciation or depreciation can affect commodity prices, making buying the same materials cheaper or more expensive.
Economic growth or shocks
Growing economies require a steady supply of commodities to produce various goods. Increasing demand with limited supply may lead to rising commodity prices. On the flip side, in times of crisis and crashing financial markets, people often turn to safe-haven assets like gold, driving their prices up.
However, as the infamous COVID-19 pandemic showed, economic turmoil means decreased production and demand for other commodities, like oil, which inevitably leads to lower prices.
How to trade commodities
With ThinkMarkets, there are two ways of doing it: commodity CFDs, stocks, and ETFs.
Commodity stocks are shares of the companies that mine, produce or process commodities. Some examples of popular commodity companies are Newmont Mining (NEM), Devon Energy (DVN) and Wheaton Precious Metals (WPM). Their price movements are usually correlated with the price of commodities they deal with.
Commodity ETFs are exchange-traded funds that are invested in commodity futures contracts. Some of the most popular commodity ETFs are iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT), Invesco DB Commodity Index Tracking Fund (DBC), and iShares Gold ETF (IAU).
With ThinkMarkets, you can trade both commodity stocks and commodity ETFs, as well as CFDs. A commodity CFD tracks the price of the underlying commodity in a futures contract, giving you giving you direct exposure without the hassle.
If you are just starting out your trading journey, it is highly advisable to practice trading on a risk-free demo account first.
