Commodity Price

A Commodity Price is the market rate for a raw, unprocessed material or basic agricultural product that is interchangeable with other goods of the same type. Think of things like crude oil, natural gas, gold, copper, wheat, corn, and coffee. These are the fundamental building blocks of the global economy, and their prices are in constant motion. The price you pay at the gas pump or for your morning loaf of bread is directly influenced by the fluctuating prices of these raw materials. At its heart, a commodity's price is determined by the timeless dance of supply and demand. However, the story doesn't end there. Modern financial markets, where traders buy and sell futures contracts to bet on future prices, also play a huge role. This means prices are driven not just by real-world use today (the spot price), but also by expectations of what supply and demand will look like months or even years from now.

Understanding what pushes commodity prices up or down is crucial, as they are a barometer for global economic health and can dramatically affect the profitability of many businesses.

The price of any commodity is fundamentally a reflection of its availability versus the world's appetite for it.

The amount of a commodity available can be affected by a wide range of issues:

• Geopolitics: A conflict in the Middle East can disrupt oil supply, while a new trade tariff can make a metal more expensive.
• Weather: A drought in Brazil can devastate the coffee bean harvest, while a mild winter can reduce demand for natural gas.
• Discovery and Technology: A major new oil discovery can increase long-term supply, while new extraction technologies, like fracking, can make previously inaccessible resources available, changing the entire market landscape.
• Production Costs: The cost of labor, energy, and equipment to mine, drill, or grow a commodity sets a floor for its price.

The desire for a commodity is equally dynamic:

• Economic Growth: When economies are booming, particularly large ones like China and the United States, construction and manufacturing activity surges, driving up demand for industrial metals like copper and steel.
• Consumer Tastes: A global health trend might boost demand for oats, while a decline in soda consumption could reduce the demand for sugar or corn syrup.
• Technological Shifts: The rise of electric vehicles is creating massive new demand for commodities like lithium, cobalt, and copper, which are essential for batteries and wiring.

Commodity prices are not just set by farmers and miners talking to factory owners. A huge amount of activity happens on futures markets, where investors engage in speculation. These traders aren't planning to take delivery of 5,000 bushels of corn; they are simply betting on whether the price will go up or down. This financial trading can add significant volatility to prices, sometimes causing them to detach from the immediate physical supply and demand dynamics.

For a value investing practitioner, commodity prices are less about a direct investment and more about a critical piece of the analytical puzzle. You aren't trying to guess the future price of oil; you're trying to understand how its price affects the long-term value of a business.

Commodity prices are fantastic economic indicators.

• Inflation Signal: Sharply rising prices across a range of commodities often signal coming inflation, as the higher costs for raw materials eventually get passed on to consumers.
• Growth Barometer: Copper is often called “Dr. Copper” because its price is an excellent proxy for global economic health. Rising copper prices suggest strong industrial demand and a growing economy, while falling prices can signal a slowdown.

This is where the rubber meets the road for a value investor.

• Input Costs: For many companies, commodities are a major cost of goods sold (COGS). An airline's profitability is tied to the price of jet fuel (oil). A packaged food company like Kraft Heinz is heavily influenced by the price of wheat, corn, and dairy. A value investor must ask: Does the company have the pricing power to pass these higher costs to its customers, or will its margins get squeezed? Does management use smart hedging strategies to protect against price swings?
• Producers' Fortunes: For companies that produce commodities—like ExxonMobil, Shell, or mining giant BHP Group—their revenues and profits are directly tied to commodity prices. These businesses are often cyclical stocks, enjoying massive profits when prices are high and suffering when they crash. Investing in them requires a deep understanding of the commodity cycle and the company's cost of production, as the lowest-cost producer is the most likely to survive a downturn.

The value investing school of thought, pioneered by Benjamin Graham, generally cautions against speculating directly in commodities. Why? Because a commodity is a non-productive asset. A bar of gold or a barrel of oil will never produce anything. It has no earnings per share, pays no dividends, and generates no cash flow. Its value is entirely dependent on someone else being willing to pay more for it in the future. This is the opposite of a wonderful business, which is a productive asset that grows and generates cash over time. Therefore, a value investor would typically prefer to own a well-managed, low-cost gold mining company that generates profits from its operations, rather than simply owning the inert metal itself. The goal is to invest in businesses, not to bet on price movements.