Home > Commodities, Economics, Finance, Investing > Commodities Investing: Demand, Supply and Speculation

Commodities Investing: Demand, Supply and Speculation

First published on BBeyond Magazine blog – an ultra niche publisher that caters exclusively for the global UNHW market and community: http://bbpublications.org/BBblogs/commodities-investing-demand-supply-and-speculation/

An unsophisticated forecaster uses statistics as a drunken man uses lampposts –
for support rather than for illumination.

– Andrew Lang

The price of a commodity is determined by demand and supply. At least that is what most of us are taught in ‘Economics 101’. The relationship between supply and demand forms the cornerstone of economic models. The most fundamental concept in economics – price – is therefore a reflection of supply and demand. Or is it? Ask anyone who has traded Brent Crude or Light Sweet Crude (WTI) oil contracts and they will tell you the oil market is driven as much by speculation and momentum as it is by demand and supply. To put it in perspective, the CFTC (Commodity Futures Trading Commission) recently revealed that almost 95% of US crude oil futures volume is generated by day trading and OPEC president Mohammad Aliabadi noted futures contract trade an astonishing 18 times higher than the volume of daily traded physical crude.

The world’s population currently stands at 6.93 billion (and counting). It is expected to surpass nine billion by 2050. As such, there has been a lot of brouhaha about our capacity to accommodate the rising demand. The rise of emerging economies like BRIC (Brazil, Russia, India, China) has pushed the prices of commodities to new highs. In the post-2007 credit crunch economic climate, despite the possibility of prolonged spells of slow growth in the developed world, demand is expected to be robust. Chinese GDP per capita alone more than doubled from $3600 in 2001 to $7600 in 2011 and is forecast to surpass $12,000 by 2016. This is a large demand explosion and the question is: How quickly can supply response to that? The prices of commodities will thus be determined using supply-side fundamentals.

In India, 60% of farmers’ produce spoils before it reaches the market. The problem therefore is not supply per se, but infrastructure (which constricts the supply chain).  New technologies can lower production costs while increasing the supply of the commodity. A technology is classified as ‘disruptive’ when it significantly lowers the supply-demand equilibrium price while it simultaneously causes a surge in production capacity. For example, the natural gas market was hit by a disruptive technology in the form of horizontal drilling. Each horizontal rig can surge production by 5-10x the previous capability of vertically drilled wells. In the past, natural gas needed to trade near $6–$7 per mmbtu (million British thermal unit) to encourage new production. Now natural gas is expected to remain under $5.50 per mmbtu for the foreseeable future. The key to successful commodities investing is to spot these disruptive technologies in the wings.

The ideas in this blog post stem from a panel discussion on Commodities Investing the author recently attended at JP Morgan, London. Chartered Alternative Investment Analyst Association sponsored the event.

 

 

Advertisements
  1. August 30, 2011 at 2:08 pm

    1250 was not the low but the August lows were the lows for SP500 and typically a deja vu- when many are away- so they seek out the panic stops which were about 300 0 points off the April highs

  2. September 1, 2011 at 11:13 pm

    Well I am guessing you must have read one of my posts else where railing against someone who went on Bloomberg and called out 1250 as the low of S&P for 2011. Bring on the double dip.

    In 2008 bank risk became sovereign risk, now in 2011 sovereign risk becomes bank risk. European banks have too much exposure to sovereign debt. Except this time, Trichet and Bernanke are running out of rabbits to pull out of their hats. This vicious cycle, economies reaching stall speed, and lack of job creation have clearly brought the 2 year bull-run to a halt.

    I have my pop corn and front row seat – looking forward to Recession Part 2 (2011) the Sequel. Just like in Recession Part 1 (2008) this time, it will be bigger, better and scarier as there is nothing the central banks can do this time round)

    Hope the options market are treating you well with such volatility.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: