Volatility is measured by the day-to-day percentage difference in the price of a commodity. The wider the price range from low to high on a daily, weekly, monthly, or longer-term basis the higher the volatility and vice versa.
The effect of volatility is difficult to measure but is generally seen as negative because it brings with it uncertainty about future price levels.
Commodity prices are mostly price inelastic, if the demand for a raw material suddenly surges, the global output cannot respond immediately. Mines can’t suddenly increase the production levels and consumers cannot always substitute one metal for another when prices rise or fall.
The impact of price volatility varies among consumers based on their overall service needs and purchasing practices. Metal prices are not only important to manufacturers and end-users but have long been used as a tool for monitoring economic and market conditions.
In this blog, we will look at the main factors affecting raw material price volatility:
1. Mother Nature
Weather and natural disasters around the world often have an effect on the price of materials. Whether that be a bush fire in Australia, Hurricane in the United States or an Earthquake in Chile An example of this was in 2010 an 8.8 magnitude earthquake in Chile caused production at four major mines to be suspended - affecting about 20% of the country's capacity.
2. Supply and Demand
Supply and demand are the most important factors in the determination of the path of least resistance for commodity prices, knowledge of production data from major producing nations is an essential ingredient in assessing total output and supplies, e.g Chile for Copper and Russia for Nickel.
Public and private sources of data are available form trade organisation, research companies and government. In addition to this, new alternative data is available such as satellite imagery, looking at points of interests along the supply chain.
Demand is ubiquitous, almost every human being on planet earth is a consumer of commodities which are the staples of everyday life all over the world. Commodities such as copper have additional indicators that can provide insight into demand, such as the health of the US housing industry.
3. Storage levels & transportation constraints
Transportation constraints of the physical commodity that occur or storage may be required along the supply chain, this is very much dependent on the type of commodity and the conditions required for transportation and storage.
High-level stock levels can be determined by looking at exchange warehouse stocks such as the LME, COMEX & SHFE and to an extent, Satellite data and AIS shipping data can be used to gain further insight into the transportation and storage of commodities around the world.
4. Geopolitics
As commodities are extracted from specific areas around the globe, political issues in those regions can affect the price of that commodity.
The Iranian’s attack on Saudi Arabia in September 2019 forced the shutdown of the facilities, cutting the country's oil production from 9.8 to about 4.1 million barrels of oil a day, losing 5.7 million barrels of oil a day or about 5% of global production, causing a 20% price rise, the largest since Saddam invaded Kuwait 30 years ago.
Logical routes being cut off, e.g in August last year (2019), Iran seized the third tanker in the Persian Gulf which had a significant effect on the price of oil.
Workers striking against copper-producing mines can occur from time to time, with the majority of copper production concentrated over a handful of areas (The top 20 mines produce 40% of the world’s copper) this can have a considerable effect on the price of copper.
The sudden imposition of a tax or tariff on imports or exports by a government (E.g in the US & China) often adds to the volatility, the health of the world's two largest economies has a strong influence on nearly every commodity.
5. Market information
There are a number of indicators of economic performance which are closely monitored as can influence the price of commodities. These include economic outputs, unemployment rates, inflation and availability and attractiveness of substitute goods (e.g replacing Copper with Aluminium).
6. Seasonality
It is important to look at seasonality for patterns in the day of the week, week of month and month of the year.
For instance, Oil goes up a statistically significant amount on a Friday. There is greater demand for Oil during the driving season in the US which runs from April through September and hurricane season can have an impact on the price of multiple commodities.
How does volatility affect consumers and others along the supply chain?
The impact of price volatility varies among consumers based on their overall requirements. When the world economy is healthy and growing, commodity demand tends to increase, and the converse is true during times of economic weakness.
Exposure to raw material price volatility varies throughout the supply chain in most cases with most of the control coming from the big players at either end of the supply chain, those extracting the materials from the ground and those providing the product to the consumer.
ChAI is helping multiple organisations along the supply chain in managing their exposure to raw material price risk through forecasting the price of raw materials. Please get in touch via the form below if you are interested in finding out more.
