The interaction of supply and demand is key to price discovery in the key commodity markets. Intuitively, higher demand tends to be linked to higher prices while lower demand puts downward pressure on prices.
On the supply side, it’s generally lower supply that leads to higher prices and elevated supply that leads to lower pricing. With commodities such as gold and silver, it can be a little more complicated; due to their safe-haven status, investors tend to buy such precious metals at times of general risk aversion.
A derivative can be thought of as a contract that allows investors to take long or short positions in assets, but without actually owning the underlying asset itself. Early derivatives enabled farmers to lock in prices for their yet-to-be harvested crops.
For instance, taking a long position, or buying a CFD in crude oil through an online platform can allow you to benefit from upward moves in oil prices. Selling a CFD on a commodity such as oil, or taking a short position, means you can profit from downward moves in prices as well.
Metals are generally divided up into precious and industrial categories, though some precious metals do have industrial applications. Gold, and to some extent silver, are special cases as their prices tend to be linked to general risk appetite.
For example, last year’s increase in geopolitical tensions in the Korean peninsula put upward pressure on gold prices as investors sought out safe havens.
Meanwhile, industrial demand drives the prices of precious metals such as palladium and platinum given their use in catalytic converters. Supply is also a big factor in the prices of palladium, with most of the world’s supply originating from just a handful of mines.
Demand and supply for copper is much less concentrated, with the result that prices tend to be more closely correlated to the global economic cycle. When the Chinese economy is at full steam, demand for copper from its vast manufacturing industries puts upward pressure on prices.
In contrast, in times of global recession, copper prices will generally decline as demand falls and oversupply becomes an issue.
For industrial metals in general, mines will be more economically viable at times of macroeconomic expansion when prices tend to be higher. In the good times, new mines come on stream as supply grows to meet rising demand.
However, when the economic environment deteriorates mines may eventually have to be closed, as lower prices make some mining operations uneconomic.
There are a wide range of agricultural commodities traded around the world, from cereals such as wheat, pulses such as soya beans as well as the likes of sugar, coffee and cocoa. Then there’s also the livestock and meat categories to consider.
In general, crop prices tend to be heavily dependent on the various harvests around the world. For instance, poor weather adversely affecting wheat crops in Russia would undoubtedly have a positive impact on global prices given the country’s status as the world’s largest exporter.
As last year’s Hurricane Irma showed, natural disasters can potentially have big impacts on the supply of commodities such as orange juice, which saw sudden sharp price rises as crops in Southern US states like Florida experienced big price rises.
Crude oil and natural gas are among the commodities that are commonly available to trade using CFDs. As with gold, the global market for crude is very deep, so bid-ask spreads, the difference between buy and sell prices, are likely to be relatively narrow.
This is good news for traders as it means their positions have a chance of coming into profit more quickly. In a vast global market, oil is constantly being bought and sold, all over the world.
As with copper, demand is linked to the global economic cycle, rising in times of expansion but falling during recessions. Inventory data is constantly being watched by market participants to give an indication of the strength of supply.
New technology has enabled producers, particularly in North America and Canada to pump greater quantities of oil at lower prices. At the same time, agreements between OPEC and Russia seek to prop up prices by agreeing cuts in production.
Markets are therefore sensitive to any news on this front; increased curbs on production, or extensions on existing output agreements tend to provide positive support for oil prices.
Oil has had a rollercoaster ride over recent years, presenting good trading opportunities. Brent crude was trading at well over $100 per barrel in 2014 yet had slumped to just $30 per barrel by early 2016 amid a global supply glut.
Helped by OPEC production cuts, Brent has since staged a recovery to trade at around $65 per barrel.
As most commodities are priced in US dollars, there generally tends to be an inverse relationship between commodity prices and the dollar. For instance, suppose the dollar rises on higher interest rate expectations, then this should have a negative impact on the price of Brent crude.
Conversely, suppose the dollar falls as risk appetite increases, then we should expect Brent and other commodity prices to generally rise.
One way to think about this relationship is to consider that non-US buyers of commodities see their spending power increase when the dollar falls.
In this article we’ve focused on the impact of fundamental factors on commodity prices. However, those trading in commodities through CFDs also tend to take into account technical factors.
Keeping a close eye on the intra-day movements of widely followed commodities such as gold and oil can reveal some compelling short-term trading opportunities. Sudden, sharp upticks or downticks in prices, as revealed by the length of the candlesticks on trading charts, may indicate strong buying or selling in the market.
Combining such information with trading volumes will also give us an idea of how persistent pricing trends are likely to be.
Bringing all these technical factors together with fundamental considerations such as news flow may help you to get more out of your trading account.