How to Perform Commodity Fundamental Analysis
In nearly every commodity business supply and demand dictate price. There are also several assumptions that will potentially alter supply and demand that need to be evaluated. The supply of a commodity can include domestic production as well as imports. The demand is a combination of consumption and exports.
Different Issues that Affect Commodity Prices
Each commodity is driven by supply and demand. Anything that could change future supply or demand should be evaluated. For example, a hurricane could reduce oil production by forcing operations to shut down ahead of a direct hit. You can categorize your commodity fundamentals to evaluate supply and demand.
Finding a Source
There are several sources of information that you can use to estimate supply and demand. This could be an official source, such as the US Department of Agriculture or the Energy Information Administration. You might also find a prive source.
Crude Oil as an Example
The fundamentals of commodity trading will be slightly different for each commodity. Energy fundamentals can be tracked using reporting groups such as the Energy Information Administration (EIA), the International Energy Agency and OPEC. London Metals Exchange metals report on inventories held in their warehouses.
The fundamentals of oil can be captured through the Energy Information Administration web site. The EIA reports on inventory levels as well as production, consumption, imports and exports. Using these tools you can formulate a view on future inventory levels.
The EIA provides information in chart format which can help you determine the future direction of inventories and whether the price of crude oil reflects that information. The chart of crude oil stocks in millions of barrels, shows the 5-year range, along with the highest level of the past 5-years at that time of year and the lowest level over the past 5-years for that time of year.
Inventories have a seasonal upward trajectory during the Q1. Crude oil stocks tend to increase ahead of the US driving season which unofficially begins on the Memorial Day Holiday in late May.
Generally, US crude oil stocks tend to rise during this time of year, which is the trajectory described by the red arrow. So far, the blue average has not experienced an upwar trajectory and appears to be sliding toward the bottom end of the 5-year average range.
External Factors
In addition to the fundamentals, commodity markets are subject to external factors that will hinder economic growth. For example, the spread of the coronavirus, which started in Wuhan China, will likely reduce growth and transportation. This will likely weigh on crude oil prices, which is a perceived threat to future demand. What this shows is that just while the trajectory of the inventory levels is likely to slide to the bottom end of the 5-year average range, it could move off track in the future do to a growth contraction generated by a coronavirus.
Take Away
The fundamentals of a commodity are its supply and demand. There are several ways to view the supply and demand of a commodity, and each is unique. In addition to measuring fundamentals, you have to understand certain external factors that can reduce or increase future demand. This could be supply shocks or demand destruction events.
To evaluate the supply and demand of a commodity its helpful to find a source that is reputable and can provide inventory levels or balance sheets. The Energy, base metal and agricultural markets all provide official sources of many different commodities.