CIPS Exam L6M2 Topic 1 Question 13 Discussion

Why Supply and Demand Fluctuate in the Commodities Market

Introduction

The commodities market is highly volatile, with prices and availability constantly influenced by fluctuations in supply and demand. These fluctuations arise due to factors such as climate conditions, geopolitical events, economic cycles, and technological advancements.

Understanding why supply and demand shift helps businesses, investors, and policymakers anticipate market trends and mitigate risks.

1. Factors Affecting Supply in the Commodities Market

1.1 Weather and Climate Conditions (Impact on Agricultural Commodities)

Why It Affects Supply?

Droughts, floods, hurricanes, or frosts can damage crops, reducing supply.

Favorable weather leads to higher yields and increased supply.

Example:

In 2019, severe droughts in Australia reduced wheat production, increasing global wheat prices.

A strong coffee harvest in Brazil led to higher supply and lower coffee prices.

Key Takeaway: Agricultural commodity supply is highly dependent on weather variability.

1.2 Geopolitical Events and Trade Restrictions (Impact on Energy & Metals)

Why It Affects Supply?

Political instability, sanctions, and wars disrupt supply chains.

Trade policies, tariffs, and embargoes restrict exports/imports.

Example:

Russia-Ukraine war (2022) led to a major disruption in wheat and oil exports, causing global shortages.

US-China trade tensions affected the availability of rare earth metals used in electronics.

Key Takeaway: Supply chains in energy, metals, and food commodities are vulnerable to geopolitical risks.

1.3 Production Costs & Technological Advancements (Impact on Oil, Metals, and Agricultural Goods)

Why It Affects Supply?

Higher production costs (e.g., fuel, labor, mining operations) reduce supply.

New technologies improve extraction and farming efficiency, increasing supply.

Example:

Shale oil extraction technology in the US increased crude oil supply, leading to lower global oil prices.

Higher fertilizer costs in 2023 led to reduced crop production in some countries.

Key Takeaway: Technological advancements increase supply, while rising production costs limit it.

2. Factors Affecting Demand in the Commodities Market

2.1 Economic Growth & Industrial Demand (Impact on Oil, Metals, and Construction Materials)

Why It Affects Demand?

Economic booms drive higher demand for oil, metals, and raw materials.

During recessions, demand for industrial commodities falls.

Example:

China's rapid industrialization (2000s) increased demand for iron ore, copper, and coal, pushing prices up.

COVID-19 lockdowns (2020) caused a sharp drop in oil demand, leading to negative oil prices in April 2020.

Key Takeaway: Commodity demand rises during economic expansion and falls during downturns.

2.2 Changing Consumer Preferences & Market Trends (Impact on Food & Energy Commodities)

Why It Affects Demand?

Shifts in diet, lifestyle, and energy use affect commodity demand.

Green energy transitions reduce fossil fuel demand but increase demand for alternative materials.

Example:

Increased veganism in Western markets boosted demand for soybeans, almonds, and plant-based protein.

Electric vehicle (EV) adoption increased demand for lithium, cobalt, and nickel used in EV batteries.

Key Takeaway: Demand changes due to consumer preferences, technological advancements, and sustainability trends.

2.3 Speculation & Investment Activity (Impact on Gold, Oil, and Agricultural Commodities)

Why It Affects Demand?

Investors and hedge funds buy commodities as a hedge against inflation or currency fluctuations.

Speculative trading increases volatility, driving short-term price spikes.

Example:

Gold prices surge during economic crises as investors seek a safe-haven asset.

Oil price spikes in 2008 and 2022 were partly due to speculative trading.

Key Takeaway: Commodity demand is influenced by financial markets and speculation.

3. How Supply & Demand Interact to Affect Prices

Key Takeaway: Prices are determined by the balance between supply availability and consumer demand.

4. Conclusion

The commodities market experiences constant fluctuations in supply and demand, driven by:

Weather & Climate -- Affects agricultural output.

Geopolitical & Trade Issues -- Disrupts supply chains.

Economic Cycles & Industrial Growth -- Determines demand levels.

Consumer Preferences & Technological Trends -- Changes demand patterns.

Speculation & Investor Activity -- Influences short-term price volatility.

Understanding these factors allows businesses to forecast commodity price movements, manage procurement risks, and optimize supply chain strategies.