Fundamental Commodity Market Analysis
Fundamental analysis focuses on understanding the supply and demand of a commodity, and then taking a view as to how those factors are likely to evolve in the future. If an investor thinks that the market is underestimating the risk of demand being too strong relative to supply, then there could be an opportunity to take advantage of a rise in prices.
This article focuses on the major financial factors affecting all commodities, and then looks at some of the key factors that affect individual commodities types. Each section includes several resources that you can use to track commodity fundamentals.
The US dollar plays a central role in the fundamental analysis of commodities. Commodities are typically priced in dollars and so a decline in the dollar versus other currencies means buyers need to pay less for each unit of a commodity. Meanwhile, a decline in the dollar can acts as a disincentive to commodity producing nations to increase output. A copper miner based in Chile for example will receive all its revenues in US dollars, but which will now buy less domestic currency.
Important for commodity investors to know that while commodity prices tend to move in the opposite direction as the US dollar, that isn’t always the case and not all commodities are affected equally. Those commodities that tend to have a local market to the US (i.e. natural gas, lumber, and livestock) are much less affected by movements in the dollar.
The second major piece of financial data that a fundamental commodity investor needs to follow is the yield on US government bonds (known as Treasuries) and the rate of inflation (the annual percentage change in the price of goods and services).
Bonds are often seen as a relatively safe asset. If the bond yield starts to rise then investors may start to move their funds into bonds and away from other riskier assets such as gold, silver and other commodities.
The state of the stock-market and attitudes to risk is the third piece of the puzzle that investors need to pay attention to. Strong appetite for risk in the stock-market tends to be good news for investors that place their money in mining companies.
There are many free resources available where you can track the price of the dollar and other ‘commodity currencies’ like the Chilean Peso, the Australian dollar and the Brazilian Real. Check out investing.com and koyfin.com for live prices. These sites will also show you the yield on government bonds and live stock-market indices.
Crude oil stocks (otherwise known as inventories) act as form of buffer for both producers and consumers of a commodity. The US is one of the most important consumers of crude oil demand and so changes in stock levels in the US are a key signal of global oil demand.
Every week the US Department of Energy (DoE) publish data on inventories of crude oil (as well as gasoline and other refinery outputs) in their Weekly Petroleum Status Report. Other countries tend to publish stock data much less frequently. 
Traders watch out for sharp changes in inventory levels, especially ahead of periods where there is likely to be high demand (for example ahead of the summer driving season). Falling stock levels occur if demand increases faster than supply, resulting in a higher commodity price.
Traders and investors try to anticipate future stock levels by anticipating what both ‘demand’ and ‘supply’ are likely to do in the future. Short-term traders look forward over the next few weeks, while longer term investors might try and anticipate what’s going to happen several months or years ahead.
The outlook for oil production is one of the main factors affecting oil prices. The oil market differs from most other commodities in that a large portion of total oil production is decided on in advance by many of the major producers. The Organisation of Petroleum Exporting Countries (OPEC) as it is known acts to co-ordinate production, keeping prices high enough to satisfy its members without snuffing out demand.
You can follow OPEC announcements on what the group claim to have produced and what they have agreed upon via their website (www.opec.org). However, what they say they are going to do, and what they actually do are often very different!
Each producer has an incentive to cheat on the agreement, and so it’s worth watching for news from key producing countries. If the government of one major oil producing country is under pressure from its citizens for reform, then it may be tempted to produce more oil, spending the revenue on subsidies for the poor.
The first sign that production may not be what OPEC says it is will be will appear is in the volumes exported on oil tankers. Follow @TankerTrackers on Twitter or check out services like Lloyd’s List for data on oil tanker use. This can often be a key leading indicator of oil output trends.
Increasingly though it is the outlook for US oil output that market participants are focused on. US oil output has grown as oil shale deposits have been exploited. The US DoE publish weekly production data, but for the fundamental investor it can be useful to follow the actions of some of the major companies operating in the region. Their investor reports can give useful insights into the cost of capital and the decline rate at their oil wells. Understanding these and other factors can help you gauge whether US oil output will expand, or contract.
This section has focused on the crude oil market, but many of the same factors and data sources apply to other energy commodities, e.g. natural gas, gasoline and other derivatives of oil.
 Note that the American Petroleum Institute (API) publish an estimate ahead of the EIA, but it is based on a smaller sample and can be misleading.
👑 Precious Metals
Precious metals (gold and silver especially) should not be interpreted in the same way as other commodities. This is because the total stock of metal mined and potentially available to use is huge compared with the amount of metal mined each year. Gold and silver are said to have a high stock-to-flow ratio. Demand — not supply — has by far the biggest fundamental impact on gold and silver prices.
Demand for gold is driven by central banks, gold-backed investment funds (e.g. ETFs), jewellery and technology. Central banks and investors tend to increase their demand for gold when they are concerned about the value of fiat currencies, inflation and geopolitical uncertainty is high. The World Gold Council is the most authoritative source to track developments in the gold market.
In contrast to gold, silver demand is primarily used in industrial applications (including solar panels), followed by investment and jewellery demand. Watch out for increased focus on renewable energy by governments — that might mean higher silver demand. The Silver Institute regularly publishes data on changes in silver demand.
Demand for gold and silver for investment tends to increase when the opportunity cost of holding the metals falls compared with alternative assets. For example, if the yield on bonds decline then demand for precious metals tend to rise as the interest lost in not holding bonds is much smaller.
🏭 Industrial Metals
One of the major fundamental signals to watch out for when analysing the commodity markets (especially the outlook for industrial metals) are trends in manufacturing output. Changes in manufacturing demand can have a significant impact on the fundamental outlook for commodities. Every month manufacturers across the globe are surveyed to gauge recent changes in output and their intentions for the months ahead via a purchasing managers index (PMI).
The PMI uses the number 50 as the baseline, i.e. neither expanding nor contracting. If the majority of respondents to the survey feel that business activity will expand then the number is above 50; if the majority feel it will contract then the number is below 50. If the PMI sinks below 50 it maybe warning of an impending slowdown; if it sinks below 45 it could be a major slowdown.
The United States PMI is published monthly by the Institute of Supply Management (ISM) and is a key statistic in assessing economic health or lack of it. The PMI can also offer the first clues of advancing inflation by indicating which way purchasing managers have seen prices going.
One of the most keenly followed countries for signs of expansion or contraction is China. China accounts for about one-fifth of global manufacturing activity. The Chinese government publishes their own PMI survey while IHS Markit publish an independent PMI covering China (plus many other economies).
In the long-term, the supply of industrial metals is determined by the rate at which new deposits are discovered and the mine becomes active. This can take 7–10 years! The fundamental commodity analyst needs to follow what mining companies say in their progress reports. If they encounter problems, then there may not be enough supply to meet expected demand.
In the short-term though you should watch out three key things: labour disputes (e.g. strike action), production problems (perhaps due to flooding or power shortages) and finally conflict (war makes it very difficult for mines to remain active and to transport mined materials to market). Useful news services to help track these developments include Bloomberg and Reuters.
Finally, watch for changes in the amount of metal held in stock. Every day the London Metals Exchange (LME) publishes how much is held in its exchange approved warehouses around the world. Other metals exchanges are run by COMEX in the US and SHME in China who also publish their own stock estimates.
The weather is a key variable that affects all agricultural commodities. Too much sun, too dry, too wet, too hot or too cold; unless the weather is just right crop yields will undoubtedly suffer. The weather has a significant impact on crop yields and thus overall agricultural production. The wrong type of weather at the wrong time in the planting cycle, even if not prolonged or extreme, can also adversely affect the production of certain crops.
The fundamental commodity analyst should focus on the longer-term outlook for the weather in key growing regions. The Climate Prediction Center of the US National Weather Service provides long-term forecasts of conditions for key growing areas across North America, while the Australian Bureau of Meteorology provides a similar service for SE Asia.
The stock of grains or other agricultural commodities has a big impact on price. If stocks are low relative to demand, then it can only take something minor to set prices spiking higher. The US Department of Agriculture (USDA) provides data on stocks, global trade and production.
You should keep an eye out for two other factors that could affect the supply: politics (governments may ban the export of produce or cut subsidies) and disease (crops can succumb to pests that cut yields).
Finally, demand can have a big influence on prices. It’s worth keeping track of consumer trends: are people buying more of one food and less of another, has one food become too expensive? You can see some of these trends in a shop near you, but it’s worth following what consumers on the other side of the world are buying as well.
TL;DR — When To Use Fundamental Commodity Analysis
Whether you are thinking of investing for the long-term or trading a short-term movement in the market you should always gauge what information is already priced in. It’s only from understanding whether a market is under-pricing the risk of a change in fundamentals that you will have an edge.
Fundamentals can take a long time to play out and impact the price of the commodity. Remember, that the change in fundamentals must be recognised by the rest of the market before the price can move sharply. This means that patience is required — easier said than done of course.
The best investments often occur when fundamentals are pointing in the same direction as technical analysis. It’s to this that we turn to in the next article. As we’ll see this can give an investor who has based his or her investment on fundamental analysis a much greater insight into the potential downsides as well as the upside.
Here’s A Little Checklist/Framework To Help
This article was written by our special guest writer, Peter Sainsbury. Peter is the author of Commodities: 50 Things You Really Need To Know & Crude Forecasts: Predictions, Pundits & Profits In The Commodity Casino. Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.