Commodity Prices

Commodity prices are the going rates for raw materials or primary agricultural products that can be bought and sold. Think of them as the wholesale prices for the fundamental building blocks of our global economy. These materials are standardized and interchangeable, meaning a barrel of Brent Crude oil from one producer is essentially the same as a barrel from another. Key examples include energy products like crude oil and natural gas; metals such as gold, silver, and copper; and agricultural goods like wheat, corn, and coffee. These prices are not set by a single entity but are determined in global markets by the constant, dynamic tug-of-war between supply and demand. Unlike the price of a branded product, which a company can influence, commodity prices are notoriously volatile and react swiftly to a host of global events, from geopolitical tensions and weather patterns to shifts in economic growth.

Understanding what makes commodity prices jump around is key to seeing how they impact the wider economy and your investments. The drivers can be broadly grouped into three categories.

Supply refers to how much of a commodity is available on the market. Anything that disrupts the flow of a raw material from its source to the buyer will impact its price.

• Production Levels: A bumper crop of corn will increase supply and push prices down, while a miners' strike in Chile could halt copper production, constricting supply and sending prices soaring.
• Geopolitical Events: Conflict or political instability in a major oil-producing region, like the Middle East, can threaten supply chains and cause oil prices to spike.
• Weather & Natural Disasters: A hurricane in the Gulf of Mexico can shut down oil rigs, and a drought in Brazil can decimate the coffee bean harvest.
• Technology & Discovery: New extraction technologies, like fracking for natural gas, can unlock vast new reserves, increasing long-term supply and potentially lowering prices.

Demand is all about how much of a commodity the world wants to buy. It's often a direct reflection of economic health and consumer behavior.

• Economic Growth: When economies are booming, factories produce more, people drive and travel more, and construction projects multiply. This increases the demand for industrial metals, energy, and other raw materials. The rapid industrialization of China over the past few decades, for instance, created a massive appetite for nearly every commodity.
• Consumer Trends: The global shift toward electric vehicles is a perfect example. It's creating immense new demand for commodities like lithium, cobalt, and copper, which are essential for batteries and wiring.
• Government Policies: Subsidies for biofuels can increase demand for corn and sugarcane, while government-funded infrastructure projects can boost demand for steel and cement.
• Strength of the US Dollar: Most major commodities are priced in U.S. dollars. When the dollar is strong, it takes fewer dollars to buy a barrel of oil or a tonne of copper. Conversely, when the dollar weakens, commodity prices tend to rise in dollar terms.

Commodities are not just physical goods; they are also financial assets. This adds another layer of complexity to their pricing.

• Speculation: Investors and traders bet on the future direction of prices using financial instruments like futures contracts and options. This activity can sometimes cause prices to detach from immediate physical supply and demand, creating short-term volatility.
• Investment Flows: The rise of ETFs (Exchange-Traded Funds) has made it easy for ordinary investors to gain exposure to commodities. Large-scale buying or selling of these funds can influence the underlying commodity prices.

For a value investor, a direct bet on commodity prices is often seen as speculation, not investment. The legendary Warren Buffett has famously pointed out that a pile of gold or a barrel of oil is a non-productive asset; it will never produce anything on its own. Instead, a value investor focuses on productive businesses. The key is to understand how commodity price volatility affects a company's long-term profitability and competitive strength.

Many companies that simply extract or grow a commodity are price takers. An independent oil driller or a small wheat farm, for example, has zero control over the selling price of its product. Their profits are entirely at the mercy of the volatile global market. When prices are high, they flourish. When prices crash, they can go bankrupt. These businesses typically lack a durable competitive advantage, or moat, and have no pricing power.

The truly great businesses are value adders. They take a raw material and transform it into something far more valuable, creating a brand and a loyal customer base in the process.

• Example: Think of The Coca-Cola Company. One of its key inputs is sugar, a commodity. But you don't buy Coca-Cola because of the price of sugar; you buy it for the brand, the taste, and the experience. The company’s powerful brand is a massive moat that allows it to manage rising input costs and maintain its profitability, regardless of sugar price swings. It is a price maker, not a price taker.

When analyzing a company, a value investor asks: Does this business have the power to thrive even if its raw material costs double or get cut in half? If the answer is yes, you've likely found a resilient business with a strong competitive advantage.

• Commodity prices are the market rates for raw materials, driven by global supply, demand, and financial market activity.
• They are inherently volatile and almost impossible to predict consistently.
• For value investors, speculating on commodity prices is a risky game.
• The smart approach is to invest in excellent businesses that use commodities but aren't controlled by them. Look for companies with strong brands and pricing power that can add value and build a protective moat around their profits.