Factors Affecting Commodities Prices

You are on a casual stroll through your local mandi, trying to buy a kilo of mustard seeds. One week the price is up, the next it’s down—thanks to unpredictable weather, fluctuating farmer supply, or rising global demand for mustard oil. Now zoom out: the same push-and-pull plays out every day in the global commodities markets.

Whether it’s oil, gold, wheat, or metals, prices are constantly shifting due to a web of interconnected factors. For traders and investors, understanding these forces isn’t just useful—it’s essential to anticipating price trends and making informed decisions.

What Affects Commodity Prices?

Commodity prices are influenced by a complex web of economic, geopolitical, and market-specific factors. These include:

1. Supply and Demand:
The most fundamental factor affecting commodity prices is the relationship between supply and demand. When supply exceeds demand, prices tend to fall. Conversely, when demand exceeds supply, prices rise. This is especially true for commodities like agricultural products and energy resources.

Example:
A poor harvest season in India can reduce the supply of wheat, pushing prices higher. On the other hand, a bumper crop can lead to lower prices as supply outpaces demand.

2. Geopolitical Events:
Political instability, wars, and sanctions can disrupt supply chains and cause significant price fluctuations. For example, a conflict in the Middle East, a key oil-producing region, can lead to a sudden spike in crude oil prices due to concerns over supply disruptions.

Example:
The oil price spike in 2020 was partly caused by geopolitical tensions in the Middle East and OPEC production cuts. Similarly, the Russia-Ukraine conflict in 2022 caused fluctuations in energy prices worldwide.

3. Economic Growth and Industrial Demand:
Economic expansion tends to increase the demand for industrial commodities like copper, aluminum, and nickel, as they are key materials in construction, manufacturing, and technology.

Example:
A rise in infrastructure development in emerging economies like India and China increases the demand for steel and copper, leading to price hikes in those commodities.

4. Weather and Seasonal Conditions:
Many agricultural commodities, such as corn, soybeans, and wheat, are highly sensitive to weather conditions. Droughts, floods, and extreme temperatures can damage crops and affect supply, which in turn leads to price changes.

Example:
The monsoon season in India plays a crucial role in agricultural productivity. A delayed monsoon or insufficient rainfall can significantly reduce crop yields, leading to higher prices for agricultural commodities like rice or lentils.

Other Key Factors Influencing Commodities Prices:

1. Currency Movements: Commodities are usually priced in US dollars globally, so fluctuations in the value of the dollar can affect the price of commodities. A stronger dollar generally makes commodities more expensive for holders of other currencies, leading to lower demand and falling prices.

Example:
A stronger Indian Rupee against the US dollar can reduce the price of gold for Indian investors, as gold is primarily priced in dollars on the international markets.

2. Inflation and Interest Rates:
Commodities like gold are often seen as a hedge against inflation. When inflation rises, the purchasing power of fiat currencies declines, leading investors to shift money into commodities like gold or oil. Additionally, rising interest rates can increase the cost of holding commodities, especially for non-physical assets like futures contracts.

Example:
When the Reserve Bank of India (RBI) raises interest rates to combat inflation, the price of gold may fall as investors shift to higher-yielding assets like bonds.

3. Speculation and Investment Activity:
Commodities markets are often influenced by investor sentiment and speculative trading. Large institutional investors, hedge funds, and commodity traders may buy or sell significant quantities of commodities based on market predictions, news, or trends.

Example:
Hedge funds and institutional investors actively trade oil futures, influencing prices based on expected demand from key markets or geopolitical events.

4. Government Policies and Subsidies:
Governments can influence commodity prices through subsidies, tariffs, and export controls. For example, a government might impose export restrictions on rice to ensure adequate domestic supply, causing international prices to rise.

Example:
India's export ban on onions in 2020 led to a sharp increase in prices globally, especially in markets like the Middle East, which are heavily dependent on Indian onion exports.

In India, factors such as monsoon patterns, government subsidies, and agricultural policies play a key role in shaping commodity prices. For instance, wheat and rice prices are directly influenced by the Food Corporation of India (FCI) and the Minimum Support Price (MSP) set by the government. Similarly, Indian farmers use commodity futures contracts on exchanges like MCX and NCDEX to hedge against adverse price fluctuations in agricultural products.

Example:
The Indian government’s wheat import policy during a bad harvest season can lead to a sudden spike in wheat prices, which affects the price of related products such as flour and bread.

Understanding the factors that affect commodity prices is essential for traders, investors, and businesses operating in the commodities market. By keeping track of supply-demand dynamics, geopolitical events, and market sentiment, participants can better manage risks and take advantage of opportunities in the commodities markets. In the next chapter, we will explore the Inflation and Commodities Correlation, examining how inflationary pressures influence commodity markets and pricing.