
Fundamental analysis is a strategy typically applied to commodity prices and thus commodity trading. The foundation of commodity fundamental analysis is the dynamics between supply and demand.
For the basics:
- Higher demand = higher prices
- Higher supply = lower prices
However, things can get a tad more complicated when you try to use fundamentals to predict prices for the future.
Commodity Supply
Commodity supply refers to the amount that is carried over from the previous production or stockpiles plus the amount that producers produce for the current years.
For example, the supply of soybeans includes the crops that farmers harvested from the past crop years. In general, higher carryover amounts to the current level means weaker price movements.
There are many factors that affect the supply of commodities. These include:
- Total acres planted
- Weather
- Production strikes
- Technology
- Crop diseases
Remember that when prices are higher, producers want to make more profits, so they tend to produce more.
Consequently, higher prices typically lower demand. With now a higher supply (due to producers producing more for profits) and lower demand, price will typically face a downward pressure.
Commodity Demand
Commodity demand refers to the amount of commodity consumed at a given price level. The general rule to follow is that demand usually increases when the commodity price moves lower.
On the flip side, the demand level for the commodity typically moves down when the prices move higher.
In other words, “low prices fix low prices.” That means low price tend to attract stronger demand, which in turn lowers the supply, which in turn increases the price.
This is a pure play of economics. At the same time, the patterns of consumption change as the prices of commodities move higher or lower.
Predicting Future Prices
Now, when it comes to predicting prices, the shorter-term approach doesn’t really work that easily. This can be possible, but due to high short-term price fluctuations, it’s incredibly difficult.
For both new and professional traders, it’s generally a better bet to use the longer-term approach. The key is to find a developing trend that will cause a change in supply and demand factors.
You can use the reports that come from:
- USDA
- Futures Exchanges
- Department of Energy
Ideally, you will have to gather current data and compare it to historical data, or the data gathered from the previous quarters or years. See how the prices reacted to the data.
Spot Trends
Another key goal when it comes to fundamental analysis in commodity trading is to spot trends, whether short term or long term.
You want to look for these trends in production and consumption without bias. You can more easily spot longer-term trends using fundamental analysis. For shorter-term trends, it’s better to use technical analysis.
For professional commodity traders, however, the bigger picture more preferable. And with commodities, or in any other financial markets, fundamental analysis does the job of painting the bigger picture.
Still, technical analysis serves as a tool to let them know the best times to enter or exit a trade.
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