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Commodity Fundamentals

Commodity Fundamentals

January 4, 2017

One of the best methods that analysts use to determine the future path of least resistance for the price of any commodity is fundamental analysis.

Fundamental analysis is the study of the supply and demand equation for any raw material market. Think of fundamentals as an equation. If supply is A and demand is B, one can determine is a market is in a surplus or a deficit condition:

If A=B: a market is in equilibrium, supply is equal to demand.

If A>B: a market is in a condition of oversupply or there is more of a raw material than necessary to satisfy demand

If A<B: a market is in a condition of deficit or there is less of a raw material than necessary to satisfy demand

When it comes to supply, the analyst will calculate the total amount of production and add that to total inventories or stockpiles of a commodity. Supply is the easier side of the equation as commodity production tends to occur in parts of the world where the raw material exists in the crust of then earth or where it can grow in a supportive climate. Trade associations and exchanges disseminate information on stockiles or inventories of commodities.

The demand side of the fundamental equation is a bit trickier because commodity consumption is ubiquitous. While commodities production can only occur in certain areas of the world, most people all over the globe are consumers. Many analysts use hedonic mathematical methods that estimate demand using economic statistics like GDP and other economic growth or contraction data.

Some countries are very good at publishing supply and demand data. For example, in the United States the USDA publishes copious data on a regular basis when it comes to agricultural commodities. The USDA data is available free of charge on their website. In the energy markets, the API and EIA publish data on gas, oil and coal production and consumption on a timely basis. In other areas of the world, stockpile data and information on consumption is considered state secrets. China and Russia are massive producers of raw materials and China is the world’s biggest consumer of almost all commodities. Therefore, when conducting fundamental analysis one must consider the limited availability of data from these critical nations and the chance that some of the information could be skewed to suit the issuing government.

Fundamental analysis is an important basis for projecting future prices of all commodities. After all, market prices go higher when there are more buyers than sellers and lower when selling is greater than buying.

Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities

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