Commodities and their effect on the global economy
What are commodities?
In economics, commodities are tangible goods – often raw resources – that can be bought, sold or exchanged. For centuries, the exchange of goods based on natural supply and demand has driven local and international trade.
To qualify as tradeable, commodities should be widely produced by many countries and companies and fairly fungible (easily interchanged). The goods available for investors diversifying into commodity trading are broadly grouped into four categories:
- Metals – primarily gold but also silver, platinum and copper
- Energy – oil, natural gas and petrol
- Livestock and meat – commonly beef, pork, lamb and poultry
- Agricultural products – farmed non-animal products like corn, coffee, cotton and sugar
Commodities and the global economy
Even with the rise of the internet and related technology like digital software and services, tangible goods continue to be a major influence on the global economy. The Russia-Ukraine war is a recent example of this: disruption to wheat production and gas supply caused huge price rises for essential goods, driving widespread inflation across Europe and pushing the UK into recession.
Aside from extreme situations such as war and environmental events, commodities and their impact on the global economy are often driven by supply and demand. This means that, although the goods themselves tend to hold their value, the returns from the commodity trades can vary vastly.
What can effect the price of commodities?
As briefly touched on, there are a range of factors that can effect the price of different commodities, with the main one being the supply and demand for each specific commodity.
Changes to supply and demand can come from natural shifts in technology and development, or from external ongoing factors like political or global events that can cause a change to the supply or demand for products or goods. This can range from droughts in agricultural countries leading to decreased crop harvests, causing a shortage of supply of agricultural goods. Similarly, as mentioned the tensions between Russia and Ukraine caused for a huge spike in crude oil prices, due to the reduced supply coming from Europes main source of crude oil, Russia.
However, these tensions not only restricted the flow of oil to Europe, but also the disruption to the agricultural exports of each country. In 2023 there was an increase in the prices of wheat, corn and soybean prices due to the restricted supply from these eastern countries.
Supply chain disruptions are a key factor in the price of a commodity, another example of this is the global shortage of colbalt and lithium, used for producing batteries for electric vehicles. We saw record highs for these battery metal commodities in 2022 due to the fears of shortage of supply, however, from 2023 onwards the slowed growth of demand in the electric vehicles market reduced the demand and saw the decline of value for these materials.
Developing countries
In particular, developing countries are most significantly impacted by changes in commodities values. This is because their economic health is often heavily dependent on the export of commodities such as rice, tea and cocoa. A temporary drop in value can cause months of economic struggle and lead to widespread poverty.
Most international trades are protected by legal agreements designed World Trade Organisation, but these regulations cannot safeguard countries against the volatility of commodity value.
Oil
Used worldwide for a range of essential tasks such as producing electricity, powering transport and heating buildings, oil is always in high demand. Although alternative energy sources are being sought out and harnessed such as solar and wind power, there is currently no global scale substitute for oil which only adds to its value.
Its importance gives the oil industry much influence on the global economy. Owners of oil supplies could use the certainty of demand to their advantage to keep prices high and limit trade with the highest bidders. This has historically caused for huge economic growth in the countries that export crude oil, with some of the worlds wealthiest nations oweing it to the crude oil production on their land. However, there are many oil laws and regulations are in place to protect against exploitation and ensure fair trade.
Inflation
Commodities tend to be resistant to inflation, rising along with it. This is due to the companies that manufacture and produce goods increasing their prices accordingly alongside the price of the raw materials and goods they buy. This makes them a popular choice for investors seeking to safeguard their portfolios against the adverse effects of rising inflation rates. However, as we have seen, changes in commodity availability, price and demand can also drive inflation.
