Commodity price volatility refers to the variation of commodity price changing around their mean value. There are several reasons that influence the commodity prices, but in general, they all relate to changes in demand or supply and the slow responsiveness of producers and consumers with respect to these fluctuations.
Nevertheless, these fluctuations are an integral part of the global economy and have different impacts on various types of businesses. Whilst markets with high price variance might be a trader's paradise that brings in great short-term opportunities; it is a disaster for investors seeking stable earnings through capital appreciation or yield. Either way, today's businesses need full insights and accurate strategies to remain profitable through volatile commodity costs.
This blog is set out to understand the driving factors behind the volatility in the commodity market prices.
Mother Nature determines weather conditions, climate change, and natural disasters, which has significant adverse effects on the price of various commodities. For instance, a prolonged hot, dry weather in 2018 affected European crop prices, especially wheat and maize. A flood in Queensland (Australia) in 2010 increased the price of the fruit and vegetable by 30%. Hurricane Harvey in 2017 shut down the largest oil refinery in the United States. These are just some examples of how Mother Nature can affect global supply and distribution capabilities, thus cause massive volatility in the commodity.
Supply and demand are one of the most fundamental factors which essentially determine commodity prices. Generally, the more information available, the less price volatility will be. Thus, knowledge of production data from major producing nations is an important ingredient in assessing total output and supplies, e.g. OPEC nations for crude oil.
Information on supply (production and inventories) and demand (consumption) are quite readily available, though not as much accurate and transparent. Regarding supply chain, countless public and private sources of data are published from trade organizations, research companies and government, and even on Google Trends. Demand information tends to be at our fingertips as almost all of us are a consumer of commodities which are the staples of everyday life all over the world. Thanks to mobile technology, ubiquitous internet connectivity and other innovations, it is getting easier to find the requested information.
Political instabilities and violent political conflicts can cause shifts in prices of commodity around the world. Russia–Saudi Arabia oil price war, for example, initiated by Saudi Arabia in March 2020 resulted in a devastating collapse in the oil price by 65% quarterly that threatened investors already nervous about Covid-19. This price war also triggered the current global stock-market crash ever since.
Furthermore, the changes in a government's tax or tariffs imports or exports regulations (e.g. in China for coal or in India for import tax changes) often add to the volatility. Undoubtedly, the world's largest economies have a powerful influence on nearly every commodity.
Fluctuations in macroeconomic variables appear to have significantly affected primary commodity price volatility. These include interest rate, exchange rates, inflation rate, economic outputs, and unemployment rates.
In time-series data, seasonality refers to variations that occur at specific regular intervals weekly, monthly, or quarterly. Seasonality is one of the main contributing factors of commodity price volatility. It is, therefore, necessary for organizations to consider these seasonal variations within their market when planning for the future. For instance, demand for consumer product-related commodities is heavily increased on Black Friday or big holidays such as Christmas, New Year, Easter. Agricultural goods, meat and products are also highly subject to the seasonal growth and harvest cycles. Hurricane season may also have a huge impact in commodity prices in the US as well as South East Asia.
Commodity price volatility can have different influences on various consumers and businesses that rely on these types of goods. On a bright side, commodity risks can be considered as part of a long-term business strategy to develop new markets or new supplier strategies. Consequently, understanding the impacts of volatility and analyzing supply chains are important exercises for organizations to better prepare for uncertainty.
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