Commodities are major assets because they are essential to the production of other goods. They are essentially derived from the Earth (wheat, soybeans, corn, gold, uranium, coal, cotton, and oil) and are considered to be fungible (interchangeable) when they belong to the same grade, regardless of when and where they are produced. They constantly traded on commodity exchanges around the world and so are not influenced by a single entity or institution. Indeed, the uncertainties in the global financial system have made commodities a reliable investment alternative to financial instruments. The price of the commodity is called commodity pricing.
Commodity prices are very persistent yet unreliable. How? It is a given that it must fluctuate! During booms on the commodity exchanges, they are always up, and during slumps, they crash so low that it seems like it was ages ago when they were so high. The market price of a commodity is primarily determined by the supply and demand for the commodity in the market. Although commodities are traded using futures contracts and futures prices, current events also determine commodity. Here are other factors that influence commodity prices:
Production Factors – Pricing is influenced by production-related factors like labor patterns, development in the tools and technologies used, trade constraints, taxes and subsidies, among others. All these factors impact on the production costs of the commodity and its prices.
Storage and Transportation Costs –Commodities need to be stored before they are distributed. The storage and distribution costs (inventory and transportation costs) of these commodities come at a cost. Although these costs are relative to the class of commodity involved, when factored in, they influence commodity prices one way or the other.
Costs involved in storage – There are two types of costs involved in storing commodities. One is the financial cost, and the other is the cost of physical storage, and they both need to be factored in when computing the forward prices.
Seasonality – Since commodities are gotten from the Earth, they are subject to the seasons too. Some seasons are more favorable to the extraction of these commodities. For example, agricultural commodities can only be optimally produced during certain seasons. Trying to produce them during other seasons will only increase production costs and ultimately increase their prices. Other examples of season-related factors are climatic conditions, operational risks and politics.
Competition: A change in the competition will always affect commodity. This change could be due to more or less producers or buyers in the market. Whatever the case might be, the excess supply of commodities may lower prices while the reverse will be the case.
Politics: Export and import policies significantly impact on commodity pricing too. For example, when a government increases the import duty on crude oil, for example, its price will be affected one way or the other.
Fluctuations in commodity can negatively impact on the commodity exchanges in particular and the global economy in general: the financial resources and income distribution of countries around the world. This is why it is important that investors understand as much as they can about the dynamics of commodity prices.