The price of a commodity’s futures contract is determined by its current spot price plus the cost of carry for the time between delivery and delivery. The cost of carry refers to the cost of storing a commodity, which includes interest, insurance, and other ancillary costs.
What factors influence commodity pricing?
Commodity prices, like stock assets, are primarily determined by market forces of supply and demand. 2 When the supply of oil grows, for example, the price of a barrel falls. In contrast, if demand for oil grows (as it frequently does during the summer), the price climbs.
How are futures pricing calculated?
Futures are financial derivatives that bind the parties to trade an item at a fixed price and date in the future. Regardless of the prevailing market price at the expiration date, the buyer or seller must purchase or sell the underlying asset at the predetermined price.
What influences commodity prices?
Weather and natural calamities have an impact on material prices all over the world. Whether it’s a bushfire in Australia, a hurricane in the United States, or an earthquake in Chile, there’s always something to worry about. In Chile, for example, an 8.8 magnitude earthquake in 2010 caused production at four major mines to be halted, affecting roughly 20% of the country’s capacity.
What are the main determinants of commodity prices?
You learned what commodities are and some of their basic properties in yesterday’s session. Today’s lecture delves deeper into the elements that influence commodity prices.
The underlying fundamentals (demand and supply) play a significant effect in the long run. These factors include income and population, production costs and technology, as well as government and producer actions. Commodity prices are influenced by a variety of factors in the near term, including weather, interest rates, and speculation.
As economies develop, industrialize, and urbanize, they often consume more commodities, especially industrial metals such as steel and energy.
However, as nations grow wealthier, commodity demand normally grows at a slower pace to match the increase in income.
Meanwhile, consumer preferences shift as nations grow wealthier, people tend to consume more protein-rich meals, which drives up demand for cattle and the crops that feed them.
The cost of manufacturing a commodity is an important factor in determining its price. Raw materials, salaries, research and development, insurance, license fees, taxes, and all other costs incurred by real-world commodity firms are included in commodity manufacturing costs.
Longer-term technology advancements may lead to higher yields (deeper mines, more durable crops, etc.) and lower marginal costs of production.
Some governments, particularly those in autocratic countries, subsidize commodity prices, particularly those in the energy and agricultural sectors, in the name of delivering a benefit to their poorest inhabitants, such as cheaper gasoline and food.
Meanwhile, some governments utilize taxes to tax consumption, and these taxes are typically levied on energy usage (particularly transport fuel). One of the reasons governments justify gasoline tariffs is to account for the environmental cost.
Commodity producers may also coordinate output reductions in order to raise prices. The Organization of Oil Exporting Countries is one of the most well-known instances (OPEC).
Too much sun, too dry, too wet, too hot, or too cold; agricultural yields will surely suffer until the weather is just right.
Weather can also have an impact on other commodities. Offshore oil producers in the Gulf of Mexico may be forced to shut down due to hurricane-force winds. Nickel miners may find it more difficult to bring their metal to market due to low water levels in Indonesia.
Lower interest rates may encourage businesses and consumers to borrow money to support investment and consumption, resulting in a rise in commodity demand indirectly.
Because the majority of globally traded commodities are priced in US dollars, changes in US interest rates are transferred to its currency, which either appreciates with tighter monetary policy or depreciates with looser policy, affecting commodity demand.
Commodities are an asset class in and of themselves. Anyone can now invest in one or a basket of different commodities thanks to financial innovation. Pension funds and other investment firms are increasingly investing in commodities in order to diversify their profits. Meanwhile, for investment funds searching for a return, commodity algorithmic trading has become more significant.
However, there are fears that speculators may be driving prices away from levels that would be justifiable if the underlying considerations mentioned in this lesson were taken into account.
All of these factors have an impact on commodity prices in some way, but their importance is amplified when global commodity stocks are low. A commodity market with low stock levels may be more vulnerable to an unanticipated supply disruption or a rapid surge in demand.
In the next session, you’ll be guided step by step through the workings of global commodity futures markets, with a focus on speculators’ critical role.
Check out my books to learn more about commodities and commodity markets.
Don’t want to read? On Skillshare, you can also watch this course as a video (first 2 months free using this link).
What is the difference between futures and commodities?
Commodities are physical products that may be bought or sold, such as oil, grain, or metals. Futures contracts are agreements to buy and sell goods in the future.
What is the purpose of commodity futures contracts?
- A commodity futures contract is a standardized contract in which the buyer agrees to buy (or the seller agrees to sell) an underlying commodity at a set future price and date.
- A futures contract also allows you to use leverage to bet on the direction of a commodity by taking a long or short position.
- Commodity futures involve a high degree of leverage, which can magnify both gains and losses.
- When it comes to reporting gains and losses on commodities futures contracts, the IRS demands Form 6781.
How do futures contracts work?
A futures contract is a legally enforceable agreement to acquire or sell a standardized asset at a defined price at a future date. Futures contracts are exchanged electronically on exchanges like the CME Group, which is the world’s largest futures exchange.
What if commodities prices plummet?
Commodity producers face a danger of lower commodity prices. A farmer may plant more of a crop on less productive land if crop prices are high this year. If prices drop next year, the farmer may lose money on the extra crop grown on less fertile land. This is a sort of commodity price risk, as well. Commodity producers and consumers can both use commodities markets to mitigate risk.
When commodity prices rise, what happens?
Instead, the tendency for commodity prices to decline when the dollar strengthens reflects the link between import prices and the US currency. Because commodity markets are denominated in US dollars, it may appear logical that as the currency increases, commodity prices will fall. Simply said, a higher US currency will have a greater influence on inflation via commodities prices rather than consumer items.
What causes price volatility in commodities?
Commodity markets have shown tremendous price volatility at various times. In many commodities, the combination of inelastic demand and supply means that unanticipated changes in demand or supply can cause huge price swings, at least in the short term.
Commodity markets have been on a steady and consistent upswing since roughly 2002. By the time it peaked in mid-2008, practically all commodity classes had suffered significant price increases. Between January 2006 and July 2008, the rate of price increases surged for numerous goods (Chart 1). 2 The price of crude oil, in instance, has more than doubled in this short time.
(a) Timber, cotton, wool, rubber, and hides make up the Agricultural Raw Materials Index.
Only two previous periods in the last century have come close to matching the speed and severity of this commodity price rise. The first was the commodity price boom in the mid-1930s, which was mostly a rebound from the Great Depression’s steep falls, and the second was the price bubble in the 1970s. 3
With the rising global financial crisis and accompanying downward adjustments to global economic growth predictions, commodity prices quickly corrected in the second half of 2008. Commodity prices plummeted rapidly from July 2008 to March 2009, undoing much of the previous years’ gains. In March 2009, broad commodities price indexes hit a low point. Commodity prices, on the whole, have recovered more than half of what they lost during the crisis. Indeed, certain commodity prices have now reached or are approaching their mid-2008 peaks.
Price volatility has increased in recent years, corresponding to the rise in commodity prices. Such volatility, on the other hand, has a long history. During the postwar period, similar levels of (nominal) price volatility have been seen at various times, particularly during the 1970s (Chart 2). 4