The commodity market, much like other financial sectors, is highly volatile and is influenced by a variety of factors. In this article, we will explore the key elements that drive this market and what traders should watch for when engaging in commodity trading. Over recent decades, global economic growth has significantly boosted the commodity market. As financial markets have become more accessible, many traders have turned to commodities in search of new opportunities. However, due to its inherent volatility, commodity trading requires careful strategy. Factors like supply and demand, currency fluctuations, geopolitical tensions, government policies, and economic development all play vital roles in this market’s movements.
Supply and Demand
The core principle of commodity pricing is that changes in supply and demand directly impact the price. When demand for a commodity increases, its price typically rises. Conversely, a decrease in supply or inventory can also drive prices higher. On the other hand, when demand drops and supply increases, prices will tend to fall.
An example of this occurred in 2020, when the COVID-19 pandemic triggered a global lockdown, causing gasoline demand to plummet. As a result, oil prices plummeted as well, with WTI crude falling to $18 a barrel in April 2020.
Currency Movements
Commodities are primarily priced in USD, so fluctuations in the value of the US dollar can influence commodity prices. When the dollar strengthens against other currencies, it often leads to a decline in the price of commodities like crude oil, gold, and agricultural products. Therefore, monitoring forex markets is crucial for understanding broader commodity trends.
For instance, gold (XAU) is often affected by changes in the dollar’s value. As a precious metal with intrinsic value, gold prices typically fall when the dollar strengthens. Moreover, inflation and commodity price shifts tend to influence each other.
Geopolitical Situations
Geopolitical instability in regions that produce key commodities can heavily influence their prices. Crude oil, for example, is primarily produced in politically unstable areas like the Middle East, meaning that tensions in this region can drive up prices. A clear illustration of this is the economic sanctions imposed on Iran, which disrupted global oil supply and caused oil prices to rise.
Similarly, the war between Russia and Ukraine, which began in February 2022, caused severe disruptions in global commodity markets, particularly affecting oil, natural gas, wheat, and other exports from Russia. These geopolitical events can directly impact the supply chain, pushing commodity prices higher due to reduced availability.
Economic Growth
The overall economic health of a country affects commodity prices through its purchasing power. This is especially true for major producing or consuming nations. For example, Venezuela, despite being a significant oil producer, has seen its oil industry deteriorate due to lack of investment and corruption, leading to hyperinflation and a crippled economy. Additionally, sanctions have exacerbated the country’s oil production problems, further driving up global oil prices.
Mother Nature
Natural events play a crucial role in the commodity market, particularly in the agricultural sector. Favorable weather conditions can lead to bumper crops, increasing supply and driving prices down. However, adverse weather such as droughts or floods can devastate harvests, resulting in supply shortages and higher prices.
For example, in April 2021, Brazil—one of the largest producers of coffee and corn—suffered severe droughts followed by frost, which drastically reduced crop yields, causing prices for these commodities to spike.
Transportation and Storage Costs
Although not always a major factor, transportation costs can affect commodity prices. In times of oversupply, for example, crude oil tankers may be used for storage, which removes them from the transportation market, leading to higher shipping costs and influencing the price of oil and other commodities.
The Bottom Line
As demonstrated, a wide range of factors influence commodity prices. Some, such as government policies, are predictable, while others, like weather events, are beyond control. It is essential to understand these factors to trade commodities effectively. Given the high-risk nature of commodity trading, it is crucial to implement sound risk management strategies and partner with a reliable provider like PFD Markets, which offers CFD trading under strict regulatory guidelines. PFD Markets provides a user-friendly platform for trading commodities, with educational resources, tools, and a demo account to help both new and experienced traders.
