Why Global Commodity Prices Fall And The Impact On Us

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Commodities generally fall into four categories: metals (gold, silver, copper, etc.), energy (crude oil, natural gas), livestock (cattle) and crops (corn, cocoa, coffee, cotton, etc.). These are all goods we consume everyday but somehow few of us really know how their prices are set. Sharp swings in commodity prices can cause major financial losses to companies operating in related industries. As we saw in the 2015 oil crisis, this led to hundreds of lay-offs in Canada, an increase in the unemployment rate, slower economic growth and a negative trickle-down effect on other industries, businesses and economic actors. So how and by whom are commodity prices actually fixed and what makes them rise and fall?

1.    Global supply and demand

According to economic theory, in a market economy, prices fall when demand drops below supply or conversely when supply increases above demand. This is a basic concept most people are able to grasp. In the most obvious cases fluctuations in supply and demand of a commodity are due to competition, weather events impacting harvests, pandemics affecting livestock and crops, the rise in costs of production (ex: labor, energy, machinery), or war. However, as listed below, there are other reasons that are not always directly related to “organic” supply and demand but which may have even larger consequences.

2.    Government policy

Governments often intervene in commodity markets to control prices domestically and abroad. A typical example is agricultural farm subsidy programs. The United States in particular have been heavily subsidizing farmers of wheat, corn, soybeans, rice and cotton for decades now. These subsidies are aimed at protecting farmers from losses; however they also foster overproduction which pushes prices down. Theses measures may be beneficial domestically but usually have dramatic effects worldwide as the market gets distorted. Today, few countries are able to compete with cheap American crops, which often get dumped in developing countries at the expense of local farmers who can’t sell their produce. Western subsidies have actually been argued to maintain the cycle of poverty in Africa.

3.    The U.S. dollar

Commodities are generally denominated in USD, which is the world’s reserve currency. However since it is also among the most expensive currencies, when the value of the dollar drops, commodity prices tend to rise, because investors are able to buy more commodities (as it takes less of their currencies to purchase a dollar). As a consequence demand increases.

4.    Cartels and big players

When a specific country or region drives most of the production (or consumption) of a commodity, it can greatly influence international policies surrounding the trade of that commodity. This happened in 2014 when Saudi Arabia, the United Arab Emirates and Iran voted against reducing global oil production. This led to an oversupply of the market and the systemic crash we witnessed in 2015 (several countries like Nigeria even fell into a recession that they still haven’t recovered from). Similarly on the demand side, if one big buyer like China experiences economic issues, then it tends to pull global demand down and prices drop. Conversely if China goes through a period of strong economic growth, its demand for certain commodities can make prices soar.

5.    Market speculation

In addition to commodity buyers and sellers, profit-driven investors such as hedge funds and investment banks play a huge role in price fluctuations. Historically, investing in commodities was a way to hedge portfolio risk, but today investors aim to make money by betting on the rise or fall of commodity prices. This has caused a lot of volatility to the commodity market, as behavioural economics and high-frequency trading have become the main drivers of market prices. Consequently, “organic” demand and supply may remain unchanged, but prices could still rise or fall depending on how investors predict the actions of other investors following the occurrence of a particular event. Some pundits believe that this is what may have happened with the cocoa crisis, with the bean losing 40% of its value in 2016. Overnight, the economies of Ivory Coast and Ghana (the world’s largest producers) crumbled as government revenues eroded and farmers started defaulting on their loans.

Conclusion

The good functioning of the global economy relies on several factors we have been taking for granted for years now, namely: the financial stability of the United States (whose massive government debt bubble may actually cause the next great depression) and the idealistic belief that markets naturally correct themselves based on the law of supply and demand. In reality, the agendas of market-making investors and policymakers are the biggest drivers of commodity prices and of essentially everything else that we consume daily. As citizens and taxpayers, we should not wait until our consuming power, our money and our jobs are put at risk before making an effort to understand the interconnection between people, governments and financial markets. At the very least, we should challenge our government representatives, reduce our dependency to the State, put enough savings aside to protect ourselves from economic turmoil and take more control of our investments.

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