How Do Supply Levels Impact on Commodity Prices?

The traditional supply and demand model is central to most financial products and investment markets, with this built on two fundamental economic principles that directly impact the price of a resource, asset or commodity.

In the case of commodities, however, the underlying financial instruments tend to be considerably more volatile, due in part to constant fluctuation in supply (especially of food staples such as wheat) and changeable levels of demand.

Certainly, the recent conflict in Ukraine (which fulfils around 30% of the world’s wheat demand) has damage wheat supplies and threatened huge food instability, creating huge price volatility in a short period of time.

But how exactly do supply levels impact on commodity values, and what are the factors that effect supply in the first place?

What are Commodities?

While the term ‘commodity’ is a relatively broad one, it typically describes a raw material that’s mined and subsequently used as part of a wider production process.

Perhaps the best-known example is the precious metal gold, which has a broad range of industrial uses and drives the global jewellery industry.

Interestingly, gold also highlights how commodities gave evolved into viable investment assets in the financial market, with this considered to be a secure store of wealth during times of economic decline and a viable hedge against inflation.

Other top global commodities (in terms of demand) include crude oil, coffee, natural gas and the aforementioned wheat, each of which are subject to the constantly changing supply and demand model and variable prices.

What Factors Impact the Supply of Commodities?

Before we look a little closer at the relationship between the supply of commodities and their price, we’re going to look at the factors that initially affect the availability of a particular commodity in the market.

Price is also a key factor here, of course, especially when measured against input costs and other financial considerations such as taxes and the number of competing sellers.

On a fundamental level, the supply and harvest of agricultural goods can be affected by adverse weather conditions, which may diminish supply and send prices higher if demand remains unchanged. As we’ve touched on, the ongoing conflict in Ukraine has also diminished and disrupted global wheat supplies, precipitating price hikes and ongoing food inflation as demand has continued to rise incrementally.

The state of technology in use at any given time can also affect supply levels, with this having a direct impact on the efficiency of harvests and specific mining projects.

Supply and Commodity Prices – The Key Considerations

The entire process of trading commodities is built on the principles of supply and demand, with this directly impacting real-time prices and the ability of investors to achieve short, medium and long-term profits.

In simple terms, disruption to the supply of commodities will see their prices rise in instances where demand remains unchanged. Conversely, a surfeit of supply will see prices fall in the same circumstances, with this directly impacting the price of oil throughout the last decade.

Commodities are also inherently volatile, due to the sheer range of factors that can impact supply and demand across the globe.

The good news is that risk hungry traders can leverage this price volatility through short-term investment strategies, as they look to trade individual price fluctuations and avoid assuming ownership of the underlying asset.