Commodity Supplies
Commodity supplies refer to the quantity carried over by the producer from the previous year (inventories) and the quantity produced during the current year. For example, current soybean supplies include the crops in the ground and the remaining amounts from prior harvest seasons. Many factors usually affect commodity supplies, such as weather, total acreage planted, production strikes, crop diseases, and technology. The main thing to remember when using fundamental analysis is that high commodity prices will lead to increased production. Everybody wants to make a profit, so producing a particular commodity when prices are higher is more profitable. Demand can also be expected to drop when prices rise enough to put pressure on prices to fall.
Commodity Demand
Commodity demand is the quantity consumed at a specific price. The rule of thumb is that demand will increase when the price of the commodity decreases. Conversely, demand will decline when the price of the commodity increases. There is an old saying among commodity traders that “low prices cure low prices.” This means that more commodities will be consumed at lower prices, reducing supply and thus prices will eventually rise. Just think about how you will drive and use more gasoline at $1.50 a gallon compared to $3 per gallon. Commodity fundamental analysis is based on simple economics. Consumption patterns change with the rising and falling prices of commodities.
Using Fundamental Analysis to Forecast Future Prices
Prices fluctuate in the short term, so it is not easy to predict commodity prices based on fundamental analysis for short-term trades. This is more challenging for new commodity traders. We recommend that new traders, and even experienced traders, use a long-term strategy when applying fundamental analysis to forecast commodity prices. You should look for developing trends that will cause changes in supply and demand factors.
To begin your fundamental research in commodities, there are several reports compiled by governmental sources – the Department of Agriculture, the Department of Energy, and futures exchanges. Many large commodity brokers also publish fundamental research for their clients. It may seem like a daunting task to find all current data and compare it with previous years to understand how prices react under those conditions. The goal is to forecast future supply and demand scenarios. Achieving this is challenging as you will be competing against experts with more data and experience, not to mention resources.
Looking for Trends
What you want to do is look for trends in production, consumption, and trade accordingly. For example, if corn supplies are at a five-year high and we have planted a record amount of corn this season, corn contracts are likely to trade with a bearish trend. You may want to trade from the short side.
At some point, corn prices will drop to a very low level and demand will rise. Additionally, weather issues may occur during the growing season, leading to reduced corn production. In these cases, you should be flexible and recognize that prices will not fall forever.
It is easier to see long-term trends using fundamental analysis, but we prefer to use technical analysis to capture short-term price movements in commodities. Most professional commodity traders like to understand the big picture of commodities through fundamental analysis and then use technical analysis to time their entries and exits. This is the essence of the techno-fundamental approach to commodity markets.
The Balance does not provide tax, investment, or financial advice. Information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risks, including the risk of losing capital.
Source:
https://www.thebalancemoney.com/fundamental-analysis-of-commodities-809310
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