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This article discusses the economic fundamentals that influence the commodities market, and trading commodities dictates an understanding of the supply and demand of commodities.
Demand plays an important role in understanding the movements of commodity prices. Understanding the forces that affect demand will help an investor to obtain expectations on future price movements, their direction, as well as their intensity.
The dynamics of pricing
The price of any particular commodity at any point in time represents how much people are willing to pay for that product. Demand, therefore, is the interconnection between price and quantity. It is intuitive to say that the relationship between price and quantity is negative. That is to say, the higher the price of a product to lower the demand. Consequently, a low-priced product will generate greater demand than a higher priced product. Many other factors affect demand besides price. These factors include marketing costs, shipping and transportation costs, finance charges, etc. The demand for the commodities traded in the futures markets is dependent upon finished products for which they are used.
The consumer is the final factor
In any free market, prices are not dictated by the producers of a commodity but by the consumers of that commodity. The market value of any product is determined by the value that product has to its purchaser. Increasing prices generally translates into higher profits for producers. This serves as a strong incentive on the part of producers to increase production so as to increase their return on investment. Consequently, greater supply to the market is a result of increased demand. On the other hand, when inventory increases at a given price level, carrying costs are increased and profitability falls. The incentive to produce is reduced. This reduction in demand will cause production and prices to fall. This is the basis of any market. Those who produce that which is in demand will profit from their endeavor. Production of goods not in demand will result in losses and failure.
Supplying price movements
While demand is a function of the consumer, supply is the domain of the producer. Understanding the supply side of the equation will allow investors to better predict the future movements of prices for the markets they are interested in. Supply of any particular good in a market is a reflection of the prices producers are willing to make quality goods over any particular time frame. It only stands to reason that no enterprise is willing to produce, unless the revenues of that production exceed their cost.
Interaction between supply and demand
Under normal conditions, increasing prices for any particular commodity will result in increasing supply to the market place. This obviously means that the relationship between supply and price is positive. Numerous other factors affect supply besides just price. These include technological innovation, costs of raw materials, introduction of new competitive products, the weather, and so forth.
Higher prices always translate into higher profits for the supplier. Higher profits offer a strong incentive for producer to increase production. Increased production results in an increased supply to the marketplace. As supplies increase, in order for prices to continue to increase or be maintained, demand must also increase. Falling prices is the market telling producers that there is excess supply.
For individuals interested in investing in commodities futures markets, a thorough understanding of the factors affecting supply and demand of any individual commodity, whether it is corn, cotton, silver, or whatever, would be extremely beneficial in taking the proper positions to maximizing their personal returns on investment.
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