The price of an agricultural commodity. Most of the news about commodities I consume is about the price. Sometime it looks like I get an infinite stream of market price information and opinions about it. Usually it is also the first discussion when you meet people at a conference about a certain commodity. It doesn’t really matter which one, either about sugar, coffee, cocoa or grains, many times a conversation starts about what the current market is doing. We all seem to be depending on a graph which we actually not can control and we all center our activities and focus around that graph.
For me it is a bit like the weather, the weather forecast is something I just have to take as a fact, when it is a rainy day and I planned a day outside, the only thing I can do is just accept. I tend to try to understand why it is rainy, but I usually get not really much further than understanding that there is a low pressure area somewhere in our neighborhood or hanging above us. Why that area is there at the first place I have no clue. One could say that I should have studied meteorology, but to be honest I look more to the price of commodities than to the weather forecast, almost needless to say that I am very curious about the price drivers of agricultural commodities.
The price drivers
What are the price drivers of agricultural commodities? Most people you ask would say supply and demand, but saying that it is similar than referring to the low pressure area when it is raining. Yes it causing for the biggest part the price, but it still does not provide a real answer. The real question should be what is causing the supply and demand? For agricultural commodities there are rather some price drivers known.
First of all again the weather, as the weather can cause good or bad crops, high and low yields influencing the supply. As I accepted in life not much influence there, we have to take it as a given. The second one is maybe not as obvious, as it is about substitution. The presence of substitution possibilities clearly has an impact. When the sugar price is high and a producer of candy can find a different sweetener as good as sugar for a lower price. Chances are high he will take that opportunity, causing a drop in demand for sugar. Another one is the current level of inventory available. Much inventory available will cause increased supply capabilities and impact the price.
Other factors to consider
Apparently we identified already three main causes, but if you want do some proper fundamental analysis for an agricultural commodity there are more factors to consider. For example health and taste: demand is influenced by this. Sugar here is a good example as the growing awareness of health related issues impacts and will impact the demand, but when a news item becomes available about the health benefits of drinking coffee or eating chocolate it affects demand. I have never seen a study of the impact of the sugar price after a very successful worldwide Coca-Cola commercial campaign, could be interesting though. Is there more? Absolutely!
Activity by investors, especially on derivative markets will have high impact. Where are the days that people really tried to ‘corner’ the market frequently as in the late 1800’s? Also protectionism by governments or releasing it, on 1 October 2017 the European Union production quota for sugar will be cease to exist for example, which will influence the sugar price. A growing world population and urbanization will cause a simple higher physical demand for processed foods. In agricultural environments the elasticity of supply definitely plays a role to. For metals it is relative easy to increase mining activity, but plant, grow it and harvest requires time and here it is not so easy to simple respond to an increased market need.
What you see is a variety of price drivers which has its effect on the price behavior of agricultural commodities. Market and fundamental analysis is therefore not so easy, and just when you think you have an idea about the influence of each driver, something happens which throws the analysis upside down. The amounts of ‘smaller’ black swans are increasing, also caused by social media influence.
I guess the discussions about the market price of agricultural commodities will keep to exist for a long time, one reason more to manage these risks and get grip on it by applying Commodity Trade and Risk Management (CTRM) software such as Agiblocks.