UNDERSTANDING THE
MACRO EFFECT ON COMMODITIES

The prices of raw materials are driven by real-world events, making them relatively easy to interpret and predict. Understand how macroeconomic factors can impact commodities, learn about price volatility and how to counteract it, and discover more about commodity supercycles.

Understanding the factors that affect commodity supply and demand levels can ultimately help you to spot price trends and potentially achieve your investment goals.

Different commodity markets have varying degrees of sensitivity to specific price drivers, while wider-reaching macroeconomic variables can send the entire commodity sector up or down in value.

What are the macroeconomic factors that affect commodities?

Commodity investors often choose to adopt a “macro” approach, making trading decisions based on global economic growth patterns and geopolitical events. Commodity investing requires investors to take an overall view on long-term trends and respond to real-time events that might impact prices in the short term. 

Supply and demand

The prices of all assets are driven by supply and demand, although it is worth considering how this can operate differently in the commodities sector. Shifts in demand can be instant and extreme. For example, news about a natural disaster can quickly disrupt the supply of a critical raw material. 

The supply of commodities is relatively inelastic, and so it can take longer to react to macroeconomic changes. For example, increasing the supply of agricultural raw materials takes at least one growing season, and it can take years for new oil wells and mines to commence production.

Data pertaining to the supply and demand of a commodity can also influence its price. Weekly crude oil inventories take place almost every Wednesday, and this is consequently the most volatile period for oil as investors learn about the current supply of the commodity.

Currency movements

Due to the global nature of commodity markets, most commodities are priced in US dollars. When the euro, pound or yen depreciates in value compared to the dollar, commodities become relatively more expensive in the UK, Eurozone or Japan. Currency fluctuations can therefore influence demand for commodities in non-US markets, as buyers adjust to changing price levels.

Weather

Weather events can have a significant impact on the supply and demand of commodities, especially in the agricultural and energy sectors. Natural disasters, such as droughts, floods and hurricanes, can disrupt crop production or impact energy infrastructure, leading to supply shocks. 

In addition, demand can also be influenced directly by the weather. For example, oil and natural gas prices are often closely linked to prevailing short-term weather conditions.

Technology

Technological advancements can impact a commodity’s supply and demand. Tech upgrades can help to improve production processes or lead to the introduction of new alternatives, for example, renewable energy resources challenging the dominance of oil and gas. 

The emergence of popular innovations and inventions in the consumer goods market can also trigger a sense of urgency to buy a specific commodity.

Inflation

Commodities tend to experience an increase in value when price levels are rising in the broader economy, with many investors buying commodities as a hedge during times of increasing inflation, because of the protection they offer. 

On the other hand, inflation can also erode consumer purchasing power and reduce aggregate demand levels in an economy. When central banks increase interest rates to counter inflationary pressures, it is possible to witness a recession, as well as a decline in demand for goods made from commodities. 

Geopolitics

Government intervention in commodity markets can be hard to predict, and geopolitical factors can significantly impact supply chains, consumer confidence and investor sentiment. Therefore, traders must do their best to respond in real-time as sanctions, trade agreements and international alliances evolve. 

Why are commodity prices volatile?

The price volatility of commodities is one of the many reasons that investors are so interested in the sector. Extreme price movements in the commodities sector are driven by the essential nature of some of the materials involved, and the potential for sudden shifts in the macroeconomic landscape.

Certain commodities, particularly foodstuffs and energy, are necessities. Therefore, any perceived risk to food or energy security can lead to spikes in demand, caused by panic buying and stockpiling. 

Natural disasters, outbreaks of war and new government directives are all events that can catch the markets off guard. As investors and analysts respond to these events, they often formulate very different, immediate conclusions on the fair value of a commodity, and time is then required for a consensus to be re-established.

How to mitigate against volatility in the commodities market

Extreme price moves are an inherent part of the commodity markets, but there are different ways of managing the risks involved. Some investors choose to allocate only a small percentage of their total capital to commodity investments, making sure the rest of their portfolio generates more stable returns. 

You can also diversify your portfolio by choosing instruments such as ETFs, which provide exposure to a wide range of commodity assets, rather than a single one.

What is the commodity supercycle?

A commodity supercycle occurs when commodity prices form an upwards trend for a sustained period. Such movements can result in prices overshooting, followed by an extended period of falling prices. These prolonged cycles are caused by the fact that demand for commodities is largely based on equally long cycles in the wider economy, and constraints make it difficult for supply to catch up with demand. 

Final thoughts

The volatility of commodity prices can be influenced by a range of macroeconomic factors. To try and maximise your returns, it is important to establish which of the many factors will have the greatest influence at a particular point in time.

Visit the eToro Academy to learn more about macroeconomics and commodities.

Quiz

FAQs

How long do commodity supercycles last?

Most investors consider a commodity supercycle to have been confirmed once prices in the sector have been consistently rising for a minimum of five years, with historical data pointing to them running for as long as 20 years.

How can I track commodity news events?

Reports on commodity production levels, reserves, consumer spending, interest rate changes and other macroeconomic factors are released according to set economic calendars. While it is not possible to predict precisely how upcoming data releases will impact prices, it is possible to be prepared for a potential uptick in volatility and to adjust your portfolio around the time of the news being released.

Does commodity trading only suit long-term investors?

No, although the long-term price movements that characterise commodity markets tend to appeal to trend traders, other types of commodity trading strategies can also be applied. The high levels of volatility and occasional extreme short-term price moves in the market make commodity trading popular among day traders as well.