How Is Commodity Price Determined?

Commodities, as opposed to manufactured goods and services, are products that are derived from economic activities like mining, agriculture, drilling, etc. And just like stocks, commodities are also traded on the markets. The intention of trading in commodities is to determine the actual commodity price, speculate on the profit or determine the cost risk. Some commonly traded commodities worldwide are gold, silver, crude oil, natural gas, copper, corn, etc.

In India, the most popular commodity exchanges are the National Commodity and Derivative Exchange (NCDEX), The Multi Commodity Exchange (MCX), the National Multi Commodity Exchange (NMCE), and the Indian Commodity Exchange (ICX). These commodity exchanges are regulated by the Commodity Derivatives Market Regulation Department (CDMRD) of the Securities and Exchange Board of India (SEBI).

Before we move to understand how commodity futures prices are determined, we must know about the two different participants in the commodity markets.

• Hedgers These participants are usually industries or businesses that have a huge requirement for raw materials. Hence, they try to reduce their exposure to price volatility by entering into a commodity futures contract with traders. With such futures contracts, hedgers make sure that their future demands for the specific commodities are fulfilled at the current price.

• Speculators Speculators are commodity market participants who do not need physical possession of the commodities traded. They enter the commodities market just to earn profits from the commodity price fluctuations. Such participants normally engage in commodity trading, where they buy and sell commodities based on speculative prices.

Just like stock prices, commodity prices also fluctuate based on multiple factors. The key factors that affect the commodity prices in the market are as follows:

• Market demand and supply The demand and supply of the commodities in the exchange play a major role in determining the commodity prices. When there is a higher demand for a commodity in the market, as compared to its supply, its price goes up, and vice versa.

• Geo-political factors Global and political factors play a crucial role in the determination of commodity prices in the country. For example, during any turmoil in the Middle Eastern countries, we may see major fluctuations in the prices of crude oil as the prices at which it is exported will be affected.

• External factors External factors like the weather can also affect the demand and supply of commodities, thus affecting their prices. For example, during winters, the cost of heating may rise, leading to a rise in demand for natural gas. This may result in an increase in the price of natural gas in the commodity market.

• Speculation As we discussed earlier, speculators enter the commodities market with the intention of earning profits from commodity price fluctuations without taking physical possession of the underlying asset. Any coordinated and sustained action by these speculators can also affect commodity prices. For example, if many speculators have a positive outlook on a particular commodity, they may start purchasing that commodity in huge quantities, thereby increasing its price.

Today, various platforms in India provide the option to trade in commodities online. Trading in commodities can be a good option to diversify your portfolio. However, you must understand what moves the commodity market and how and be aware of the risks involved. Before investing your hard-earned money in commodities, you must thoroughly research every aspect of commodity markets. While trading in commodities can offer high returns, it also comes with a high risk.