Raw material prices - Causes of change

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Commodity prices are highly volatile in financial markets.Speculation is often blamed for these variations, but we will see that it is changes in supply and demand that are the main determinants of commodity prices. Supply and demand are constantly changing due to both short and long-term factors.It is these elements clashing that causes raw material prices to fluctuate.
raw material

Changes in the supply of raw materials



Short-term factors

- Weather conditions: We often hear about it through the media, the vagaries of the weather (cyclones, floods, drought, etc.) wreak havoc on the supply of raw materials.Poor weather results in a poor harvest and therefore reduces supply.The impact is bigger or smaller depending on whether the affected country is a major producer of the raw material or not. For example, the price of wheat will be strongly impacted in the short term if France suffers a severe drought (France being the 4th largest wheat producer in the world).If supply is lower, commodity prices rise.

- Political crises:There are numerous political crises throughout the world, particularly in African and Gulf countries. These countries are large producers of raw materials.Iraq, for example is a case in point (7th largest oil producer).When one of these countries is hit by a political crisis, it creates great uncertainty about global supply.Moreover, these events are often unforeseen and create uncertainty in financial markets, leading to higher commodity prices.

- Hydrocarbon prices:An increase in the price of hydrocarbons (oil, gas, coal, etc.) has the effect of increasing logistical costs linked to the transport of raw materials and also operating costs.As a result, the price of raw materials rises overall. Conversely, a fall in the price of hydrocarbons puts downward pressure on commodity prices.

Long-term factors

- Economic policies: The change in agricultural policy of a raw material importing country has a strong long-term impact on supply.If a State decides to develop its agriculture, it will, for example, increase subsidies to farmers, which will enable them to develop their farms by making new investments (increasing production capacity). This is the case with the new common agricultural policy in France, which also helps young farmers to set up in France (implemented in 2015).

- Trade policies: Trade liberalization with the opening of new borders, a reduction in export taxes favours trade. The cost of exporting is then made at a lower price, which pushes farmers to increase their production to meet the growing demand.The supply therefore gradually increases. A reduction of import duties has the same effect.

- Technological innovation: Technology is constantly evolving and improving the productivity of farms. For example, some machine tools replace people for a specific task or a machine tool is replaced by another, more efficient one.All of this leads to an increase in production capacity to meet ever-increasing global demand.

Change in the demand for raw materials



Short-term factors

- Dollar exchange rate: Commodities are mostly quoted in US dollars.Generally speaking, a rise in the dollar causes a drop in commodity prices, which increases demand. Conversely, a fall in the dollar leads to higher prices and therefore lower demand.

However, the impact of an increase/decrease is more or less significant depending on the weight of the United States in importing that particular raw material.If the United States is a major importer of a raw material, a rise in the dollar has a stronger impact on world demand.Effectively, a rise in the dollar allows the United States to import more raw materials for an equivalent amount in foreign currency. This favours exports to the United Statesfrom other countries.If global demand rises, prices rise and the selling pressure associated with the rising dollar is not as strong.

Conversely, if the United States is a major world exporter of a raw material, the pressure on the price of the raw material is even greater.Effectively, American products become less attractive due to the rise of the Dollar, which reduces world demand and thus accentuates the drop in prices (related to the rise of the Dollar).

Long-term factors

- Economic conditions: World demand for raw materials is linked to economic activity and more particularly to the industrial activity of the major importing countries. If the economic conditions are bad, demand is weaker.If the economic conditions are good, demand increases.The more a country is a major importer, the more its economic activity will have a significant impact on the price of the raw material.

- Technical progress: Technological innovation plays a very important role in global demand.In fact, technical progress makes it possible to reduce raw material consumption. An innovation can either make a machine less greedy (e.g. car engines that consume less and less) or offer a substitute for the raw material. This is the case, for example, in textiles with the manufacture of synthetic fibres.Another example is the case of electric cars, which do not require petrol (or very little) to run.

Conclusion



Changes in supply and demand mean that the prices of materials are constantly changing.Short-term factors tend to create volatility in financial markets, while long-term factors determine commodity trends.With the development of emerging countries and the growth of the world's population, supply is attempting to respond to a trend of increasing demand. If the supply doesn't follow suit, prices go up.

Speculation is often cited on the prosecution's bench, in changes of commodity prices.Speculation increases the volatility of commodity prices, but it only responds to events linked to changes in supply and demand.In many cases, the response is overreaction and this creates a considerable increase in short-term volatility.

In the long term, supply and demand remain the basis for setting the price of a raw material.

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