A recurring theme in commodity markets over the past couple of years is the increase in volatility, which 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 creates uncertainty about future price levels. This issue of uncertainty has grown in stature over the past two years as a number of different factors have contributed to a record period of commodity price volatility.
The impact of price volatility varies among consumers based on their overall service needs and purchasing practices. Nonetheless, the disruption of global supply chains, unpredictable patterns of demand and challenging geopolitical environment since the beginning of Covid pandemic have contributed to commodity price volatility affecting all aspects of consumer life. In this piece, we will look at some of the main factors affecting raw material price volatility.
Supply and Demand
Supply and demand are the fundamental forces that drive commodity prices; all other things being equal, an increase in supply or decrease in demand for a specific commodity will lower its price, and vice versa. An example of this market dynamic at play was the oil production cut recently announced by OPEC+ which contributed to a rise in the price of Crude Oil.
Knowledge of production data from major producing nations is an essential ingredient in assessing total output and supply of any given commodity, e.g Chile for Copper and South Africa for Platinum.
Demand is ubiquitous; almost every human being on planet earth is a consumer of commodities in some form. Changes to patterns of consumption, and therefore price, can occur for a number of reasons; the prices of most industrial metals have declined in the past 6 months due to Covid lockdowns in China which have reduced demand from the nation’s construction and automotive industries. In the agricultures space, the decline of cocoa prices in the past 6 months is partly due to spiralling living costs which have decreased consumer demand for chocolate.
Outside of the supply and demand for a specific commodity, the wider economic conditions surrounding commodity trading are influential in driving prices. There are a number of indicators of economic performance which can be closely monitored in this regard, including economic outputs, unemployment rates, availability and attractiveness of substitute goods (e.g replacing Palladium with Platinum).
At present, inflation rates around the world are both being driven by, and then directly affecting, volatility in commodity markets. Similarly, actions taken by governments to address inflation, such as raising interest rates, are impacting both consumer discretionary spending and currency exchange rates which also drive commodities prices.
Weather and natural disasters around the world often have an effect on the price of materials, and these issues are increasingly disrupting global supply chains and therefore commodity prices. Examples of this can be found across various raw material types; in 2010 an 8.8 magnitude earthquake in Chile caused production at four major copper mines to be suspended - affecting about 20% of the country's capacity. In 2021, a frost swept across key coffee-producing regions of Brazil leading to an estimated 5 million bags of Arabica coffee being lost from the harvest. Recently, a summer drought in the US Midwest has raised concerns about the size and quality of this year’s corn yield in one of the major producing regions of the world.
As commodities are extracted from specific areas around the globe, political issues in those regions can affect the price of that commodity. Geopolitical issues can arise in many different formats including export bans, tariffs, protests, and conflicts. The latter of these has been at the forefront of driving commodity price volatility in 2022, with Russia’s invasion of Ukraine impacting markets even beyond those of goods directly produced in either nation.
The repercussions of Russia’s invasion has led to the imposition of restrictions on trading Russian-sourced commodities, such as oil or Aluminium. Meanwhile, Russia has retaliated to perceived western antagonisation by limiting natural gas exports to Europe which has led to record gas prices across the continent. Elsewhere, India restricted exports of wheat earlier this year to protect against uncontrollable rises in domestic food prices, while Indonesia temporarily banned exports of palm oil for similar reasons.
Speculators are those commodity market participants who buy or sell assets, such as derivative contracts, without ever directly handling the material. While they are often branded with a negative reputation, particularly during times of high prices when the accusations of selfish profiteering become frequent, financial speculators play a key role in global commodity markets. One aspect of this role is providing liquidity to markets, bridging the gap between producers and consumers. They also help to reduce the risk of market manipulation, which is easier in markets which have only a few major participants.
Storage Levels & Transportation
The costs of transporting and storing a physical commodity can significantly increase the price for the consumer, although 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 and vessel tracking data can be used to gain further insight into the transportation and storage of commodities around the world. Tracking indicators such as the Baltic Dry Index, which measures the cost of shipping goods worldwide, can also provide valuable insights. A memorable recent example of transportation issues in supply chains was the Ever Given container ship running aground in the Suez Canal in 2021.
Seasonality is another important factor, and is essentially the result of uneven distribution of supply and demand over time, so it is important to monitor patterns in commodity pricing according to the day of the week, week of month and month of the year. A notable case of the seasonality effect is the US driving season which traditionally runs from Memorial Day weekend in late May through to Labor Day in September and marks the period of highest annual gasoline demand in the United States.