Commodity Market Fundamentals

Commodities are raw materials: energy such as crude oil and natural gas, metals such as gold and copper, and agricultural products such as corn, wheat and coffee. Unlike stocks, commodities do not pay dividends or have earnings. Their prices are set by physical supply and demand, by the cost and availability of storage, and by the flows of investors and hedgers in futures markets. Understanding these fundamentals is the starting point for trading commodities. The short introduction is in What Are Commodities?.

Commodity sectors#

See Energy Markets, Metals Markets and Agricultural Markets.

Supply and demand basics#

Commodity supply is often slow to respond to prices. A new copper mine can take ten years to develop; farmers plant once a season. Demand can also be slow to adjust in the short term, because people still need fuel and food. As a result, small imbalances can cause large price swings, especially when inventories are low.

Key price drivers#

Market participants#

• Producers: farmers, miners, oil companies, who hedge by selling futures.
• Consumers: airlines, food companies, utilities, who hedge by buying futures.
• Merchants and traders: firms such as large commodity trading houses that move physical goods and arbitrage between locations.
• Speculators: funds and individuals betting on price moves.
• Index investors: funds tracking commodity indices.

Key data sources#

See Trading Economic Releases and Sentiment Data.

How commodities are traded#

• Futures on exchanges such as CME (NYMEX, COMEX, CBOT), ICE and the London Metal Exchange. See How Futures Contracts Work.
• Options on futures.
• ETFs and ETNs, which usually hold futures and face roll costs. See Roll Yield.
• Shares of producers, which add company specific risks.
• Physical markets for large commercial players.

The futures curve#

Commodity futures curves reflect storage costs and supply tightness. Contango signals ample supply; backwardation signals tightness. The curve also determines roll returns for long term investors. See Contango and Backwardation.

Frequently asked questions#

What drives commodity prices?#

Physical supply and demand, inventory levels, economic growth, the US dollar, interest rates, weather, geopolitics and investor flows.

Why are commodity prices so volatile?#

Because supply and demand respond slowly to price changes in the short term, so small imbalances can cause large price moves, especially when inventories are low.

How do individuals trade commodities?#

Mainly through futures, options on futures, ETFs and shares of commodity producers.

Next, learn how the calendar affects commodity prices in Seasonality in Commodities.