Analysis of Commodities Fundamentals

Zarith Sofea · 03 Apr 9.3K Views

Fundamental analysis involves examining commodities to anticipate their future price trends based on the principles of supply and demand.

When analyzing commodity prices, the fundamental concept of supply and demand can be simplified into a basic equation. However, forecasting future prices becomes more complex.

Commodity markets operate in cycles. At times, a commodity like oil or gold may experience tight supplies, causing prices to rise. Conversely, when there's an oversupply, prices tend to decline. Traders and fundamental analysts often focus on commodities trading at multi-year highs or lows, as these situations can signal potential trading opportunities when the market dynamics shift.

Price movements in commodities can be summarized using fundamental analysis with the following formulas:

High Demand and Low Supply lead to Higher Prices

Excess Supply compared to Demand results in Lower Prices

Supply of Commodities

The supply of a commodity encompasses both the existing stockpiles carried over from previous production years and the current year's production. Take soybeans, for instance, where the current supply includes the crops growing in the fields and the remaining stock from previous harvests. Generally, a higher carryover from the previous season tends to depress prices.

Numerous factors influence commodity supply, such as weather conditions, the extent of planted acreage, labor strikes, crop diseases, and advancements in technology. It's essential to recognize that in fundamental analysis, elevated commodity prices stimulate increased production. Since profitability is a driving force, producers find it more lucrative to supply a commodity when prices are high. Consequently, heightened prices typically lead to decreased demand. Should demand decline significantly, it exerts downward pressure on prices.

Demand for Commodities

The demand for commodities refers to the quantity consumed at a particular price level. Generally, when the price of a commodity decreases, demand tends to increase, and conversely, when the price rises, demand tends to decrease. This principle is often encapsulated in the adage among commodity traders that 'low prices cure low prices.' This suggests that lower prices stimulate higher consumption, leading to a reduction in supply and eventually causing prices to rise.

Consider, for example, how one might drive more and consume more gasoline when prices are $1.50 per gallon compared to when they are $3 per gallon. This reflects a basic understanding of fundamental commodity analysis, which revolves around the simple economics of consumption patterns responding to changes in commodity prices.

Utilizing Fundamental Analysis for Price Forecasting

Prices of commodities tend to fluctuate in the short term, making it challenging to accurately forecast them for short-term trades based solely on fundamental analysis. This difficulty is amplified for new commodity traders. Therefore, we advise both new and experienced traders to adopt a long-term strategy when utilizing fundamental analysis to predict commodity prices. It's essential to identify emerging trends that could impact supply and demand dynamics.

To initiate fundamental research on commodities, one can refer to various reports compiled by government entities such as the USDA, Department of Energy, and Futures Exchanges. Additionally, many prominent commodity brokers offer fundamental research reports for their clients.

While gathering current data and comparing it to past trends may seem daunting, the objective is to anticipate future supply and demand dynamics. However, achieving this is challenging, given the competition from experts who possess extensive data, experience, and resources.

Looking for Trends

To effectively trade in commodities, it's important to observe trends in production, consumption, and trade. For instance, when corn supplies reach a five-year high and there's a record planting of corn acres for the season, it's probable that corn futures will trade with a downward bias, making short trades preferable.

However, it's essential to remain flexible as prices can't decline indefinitely. Factors like increased demand due to low prices or weather-related production issues can cause prices to rebound. While fundamental analysis helps identify longer-term trends, many traders prefer using technical analysis for short-term price movements. This blend of fundamental and technical analysis is known as a Techno-Fundamental approach to trading commodities.

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