Why are commodities more volatile than other assets?

Commodities are considered assets that exhibit higher volatility than other assets, and there are several reasons for this:

1. Liquidity

Stock, bond, and currency markets attract a massive volume of trading daily. However, many commodities traded on futures markets provide less liquidity or significantly lower trading volume compared to other major assets. Although oil and gold are the most traded commodities, these markets can sometimes become highly volatile due to the potential for internal or external events.

2. Nature

Nature determines the weather and natural disasters that occur around the world from time to time. An earthquake in Chile, the world’s largest copper producer, could lead to a spike in the price of the red metal. Drought in the United States could result in higher corn and soybean prices due to reduced crop yields.

3. Supply and Demand

Supply and demand are the primary factors driving commodity prices. Commodities are produced in areas of the world where soil or climate supports agriculture and where reserves exist in the earth’s crust that can be extracted at a cost lower than the market price. Demand, on the other hand, is ubiquitous. Almost every person on the planet consumes commodities, which are the foundation of daily life. Therefore, the supply-demand equation for raw materials is what makes them one of the most volatile assets in the world in terms of prices.

4. Geopolitics

Because commodity reserves are located in specific areas of our planet, political issues in one region often impact prices. For example, when Iraq invaded Kuwait in 1990, the price of crude oil doubled in the following weeks on contracts for crude oil on the New York and Brent exchanges. When the U.S. president released oil from the Strategic Petroleum Reserve, the price of oil halved.

5. Leverage

The traditional way to trade or invest in commodities is through futures markets. Futures contracts offer a high degree of leverage. A buyer or seller of a futures contract only needs to deposit a small amount as good faith or margin to control a much larger financial interest in a commodity. The initial margin percentage typically ranges between five and ten percent of the total contract value of the commodity. Thus, leverage in commodity contracts provides traders and investors with greater opportunities compared to other assets.

Commodities tend to be the most volatile asset class. Understanding and monitoring volatility is an important exercise for both investors and traders. When determining the risk-reward profile for any asset, volatility is a statistical measure that will help in setting benchmarks.

Source: https://www.thebalancemoney.com/why-commodities-are-volatile-assets-4126754