Commodity trading: What are the factors affecting prices of commodities?
The commodities market today is advanced, using various financial instruments such as derivatives, futures, options, swaps, etc. In India, there are six commodity exchanges, the most prominent ones being the National Commodity and Derivative Exchange (NCDEX) and the Multi Commodity Exchange (MCX). On these exchanges, commodity trading is carried out for various commodities such as gold, silver, natural gas, copper, soya bean, corn, crude oil, and many more items.
Commodity trading allows an individual to diversify their investment portfolio through investing in various perishable and non-perishable commodities. Investing in commodities not only helps to mitigate the risk but also helps to hedge against rising inflation.
There are various factors that play an essential role and are considered while calculating the price of different commodities traded in the commodities market. Before a trader steps into the world of commodity trading, it is vital to understand how prices of commodities are likely to move. Let us look at some of these factors affecting the prices of commodities.
Factors of Demand and Supply: The market price of the commodities is heavily regulated by the market demand of a particular commodity and the consequent supply of the goods that are being traded on a commodity exchange. When the buyers of a specific commodity are in the majority, compared to sellers, the prices rise, and vice versa. The factors of demand and supply are influenced by external factors as well, for example, the cost of heating goes up in the winter and this leads to high demand for natural gas as a commodity thus increasing its price.
Eco-Political Factors: On a broader scale, the politics and economics of a nation play a role in the price variation of commodities. If there is any political/economic instability in a single or more OPEC (Organization of Petroleum Exporting Countries), it will likely affect crude oil prices, as most of these commodities come from here. Similarly, prices of steel are largely dependant on worldwide economic factors as it is a massively and internationally used commodity.
Speculation: Along with other external factors, the demand for commodities is also affected by the actions of speculative investors who enter the market with the objective of making quick profits through price fluctuations. These individuals make predictions regarding the direction of price movement. The investors who expect the prices to drop in the future can undertake a short position to realize profits through a fail at the market price. Whereas, the investors who expect the prices of the commodities to rise in the future can opt for a long position so as to sell the commodities in the commodities market at a higher price in the future