Commodities have become a quick resort for investors amid the current instability in the equities market that followed major 2022 macroeconomic shifts such as tightening financial policies in the US and other major markets, Russia's invasion of Ukraine, as well as the persisting impact of the COVID-19 pandemic.

With a defensive nature against inflation and historically low to negative correlation with stocks or bonds, commodities can be effective in minimising risk in a diversified portfolio. Experts suggest that between 5% and 10% of your portfolio should be allocated to a mix of commodities. However, while commodities can provide protection, their prices are extremely volatile and can be swayed by weather, politics, global supply, and demand. Success in trading commodity equities or futures contracts requires investors to be able to anticipate future price movements while managing market risk through proven trading strategies.

Commodity Market Analysis

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In anticipating how commodity prices will change in the future, market analysts and commodity traders use a mix of fundamental and technical strategies to decide the best time to enter a trade. Fundamental analysis allows traders to get a bigger picture of the commodity market by focusing on fundamental market factors that affect commodity prices. However, fundamental price forecasts are not very effective for short-term trades, as they typically pay attention to market trends with multi-year highs or lows and require patient research of numerous reports on production and consumption. Technical analysis, on the other hand, utilises specialised strategies to analyse recent price patterns and levels on trading charts to indicate future price trends. Technical analysis is most effective for short-term commodity trading and can reinforce fundamental forecasts by helping traders time their market entry and exit.

Fundamentals of Global Commodity Prices

Commodity price volatility is caused by various macroeconomic factors that affect global supply and demand. The World Bank reports that since 1996, global demand shocks have accounted for 50% of global commodity price fluctuation, while global supply shocks have accounted for 20% percent. Fundamental forecasts of commodity market fluctuations are developed by analysing current market forces that cause these supply and demand shocks. These forces can have either a positive or negative effect on global demand or supply.

Global Demand Shocks

A positive demand shock results in a sudden increase in production output that is accompanied by rising commodity prices. A positive demand shock causes inflationary pressures to rise as the economy produces more to meet rising demand. On the other hand, a negative demand shock results in falling GDP and price levels as demand for goods or services decreases. A negative demand shock can cause production to be below capacity leading to falling profits and an economic contraction.

Sources of Demand Shocks

1. Global recession
2. Dramatic change to fiscal and monetary policies
3. Sudden change in consumer confidence
4. An unexpected change in international trade conditions
5. A significant shift in global liquidity levels

Global Supply Shocks

A positive supply shock is a sudden increase in production output that results in more of a commodity being available in the market and thus causing price levels to fall. A positive supply shock can decrease inflationary pressures as it achieves maximum production at reduced prices. A negative supply shock however causes a drastic fall in production output, as prices rise, leading to an economic contraction. Negative supply shocks can lead to economic deflation as the unemployment rate rises and economic growth falls.

Sources of Supply Shocks

1. Sharp surge/drop in oil prices for energy and transportation
2. Sudden change in labour costs
3. Unexpected weather changes or natural disasters
4. An unexpected change in international trade conditions
5. Technology shocks

Technical Indicators for Commodity Market Analysis

Technical analysis focuses on identifying buy and sell signals by using various chart indicators to examine recent price patterns. While it can be challenging to select from the wide variety of available technical indicators some of the most common techniques which have proven to be accurate for a majority of investors include moving day averages and relative strength index. 

Moving Averages

This indicator smooths out price fluctuations by reflecting the average price of an asset over a specified period of time. It is appropriately used in momentum markets where there is a strong price trend, as opposed to a ranging market. A 10-period Moving Average represents the average of the closing price for a commodity over the last 10 days. This indicator is a simple way to identify short-term buy, hold, or sell signals. When prices move above the moving average line, it is usually a signal to buy. Similarly, declining prices are a signal to sell. Moving averages can be calculated for various periods, such as 3-day, 10-day, 21-day, 50-day, 100-day, or 200-day moving averages. The longer period moving averages can act as a good indicator for long-term signals.

Relative Strength Index (RSI)

RSI is another common technical indicator for commodity analysis and is appropriate in a momentum market. This indicator attempts to identify overbought or oversold levels  in a market on a scale of 0 to 100, where above 70 indicates an overbought position and below 30 is considered an oversold position. The use of a 14-day RSI has been recommended by many experts, however, the 9-day RSI and 25-day RSI are also commonly used. Relative Strength Index can also be used to Identify divergence — when the price of an asset is trending in another direction as compared to the RSI indicator.

Trading Strategies for Commodities

Commodity traders can employ various strategies based on technical or fundamental analysis, or a mix of both to make a trade decision. It is important to decide on the strategy that can guide your entry and exit positions from a trade based on your investment goal and risk tolerance. Here are a few strategies that are commonly used: 

1. Trend trading strategy uses fundamental analysis to forecast price direction, with an upward trend often a good indicator to hold a long position or switch to short selling when price direction point downwards.
2. News trading strategy also focuses on fundamental analysis by looking for information in the news that signals a change in commodity prices like extreme weather or political events. 
3. Range trading is a short-term trading strategy that takes advantage of short-term movements by identifying support and resistance levels on the price chart. Range traders buy when prices are close to the support level and sell when prices are near resistance levels. 
4. Breakout trading strategy also focuses on looking for profit opportunities on short-term price movements. A breakout trader focuses on buying a commodity moving above its recent trading range and holding as the price moves higher, or selling just as it hits its resistance level.

Although commodity trading can be complex due to price volatility and unpredictable market factors, it still remains highly recommended for portfolio diversification, and with a mix of fundamental and technical trading strategies you can discover profit opportunities in the market. 

Anahit is an asset analysis platform that provides a mix of technical, fundamental, and macro indicators to help you gain a bigger picture of the market while leveraging artificial intelligence to help you predict future price patterns for commodities and other asset categories.