Commodity Market Fundamentals - What to consider?

Commodity Market Fundamentals - What to consider?

Fundamental analysis does have its place in commodity trading and technical analysts can benefit from fundamental research. Fundamental Analysis attempts to forecast the future value of a commodity by analyzing current and historical data. Analysts try to see if the commodities price is over or under valued and what that means to its future.

Fundamental analysis consists of looking at the cost of production in relation to the commodities current price, and the world supply / demand situation.

The cost of production is an important issue in many commodities, because the farmers or producers are not going to continue producing the commodity if the price drops below production costs. This was just recently evident in the cocoa market where producers were burning their harvest rather than selling it below production costs.

The world supply and demand fundamentals are important as well. Naturally, if demand is out pacing the supply we can expect prices to rise. And vise-versa if supply is out pacing demand.

Many traders trade strictly off of fundamental information. But this requires an extensive amount of work and research to design a trading strategy by. In my opinion, it takes away from the simplicity of commodity trading. However, as technical traders we can incorporate the overall fundamental analysis into our trading decisions easily.

As an explanation, we don't need to know everything there is to know about a soybean plant to successfully trade soybean futures. However, we should know in what locations around the world the plant is grown, what the overall world supply situation is and what the import and export demand is. We also have to be aware of possible adverse weather events around the world like droughts and floods.

The main source for this information is easily obtained from the United States Department of Agriculture (USDA), and market news sources like Futures World News (FWN). In the Virtual Trading University students web site you will find a link directly to the USDA reports calendar that tells you the date and times that these reports are released. There is also a link to the FWN news web site where you can gain information on trader's expectations for these reports and other news pertaining to the markets.

Traders should take a cautious stance if they are trading in a market when a USDA report is scheduled for release. The reason being, the USDA numbers quite often do not match what the market traders are expecting, and prices can become very wild. For that reason I suggest closing out futures trades before these reports are released.

The December 1999, hog chart above is a prime example of what can happen when a report is released that is different than traders were expecting. This particular Hogs and Pigs USDA report indicated that there were many more hogs than the traders were expecting. This high number came at a time when the summer demand was letting up and resulted in much lower prices.

This market did trade limit down for four days before prices stabilized and if you had been long the market (expecting prices to rise) you would have been in trouble. Of course, if you were short (expecting prices to decline) you would have done well.

My point is you had no idea what that report contained before it was released, and it's the unknowns of commodity trading that can wipe you out. If you're not sure about a commodity trade, the best thing to do is get out, or stay out.