How Does Volatility Impact the Commodities Market?
Volatility impacts the entire commodities market. Learn here how it happens and the role of hedging in managing risks and protecting businesses.
Volatility is inherent in the commodities market. In recent years, the world has faced the effects of the COVID-19 pandemic, coupled with the developments in the Ukraine war. Additionally, climatic phenomena like La Niña have brought negative consequences to various regions.
These events bring about changes not only to production chains but also to the daily lives of the population. Production and consumption dynamics are altered and often result in sharp price fluctuations for food, fuels, and agricultural inputs.
How is all of this interconnected with volatility in the commodities market and the importance of risk management? That’s what you will discover in this content.
What Is Volatility in the Commodities Market?
Volatility is a variable that allows for the analysis of the frequency and intensity of price fluctuations of a certain asset over time. In the case of commodities, whose prices are mainly determined by international supply and demand, volatility highlights the degree of sensitivity of the market to factors that can trigger changes in product values.
In practice, extremely volatile commodities can experience significant price variations in a single day. Thus, volatility serves as an indicator for traders to have prior knowledge of possible price scenarios for the commodity.
To understand how volatility occurs in practice, consider a Brazilian company that relies on Arabica coffee. On the first day, a 60kg sack of coffee is quoted at R$ 800 on the reference physical market exchange. The next day, the same quantity costs R$ 750. In other words, coffee underwent a significant price fluctuation in a short period.
What Factors Cause Volatility in the Commodities Market?
Volatility is subject to a series of factors that can trigger price variations. Changes in supply and demand are the main drivers of commodities’ volatility. Any event that affects production and/or consumption can influence supply and demand, such as:
- Weather Conditions
Weather conditions play a critical role in the commodities market. Droughts, floods, and frosts can modify crop production and, consequently, food prices.
For example, La Niña causes droughts and floods, varying according to the affected area. In Latin America, this natural phenomenon ended in March 2023 after a 3-year duration. Characterized by the cooling of Pacific waters, its local effects were intense on crops like wheat in Argentina.
The 2022/2023 Argentine wheat harvest was the worst in recent years, marked by a historic drought resulting in 10 million fewer tons produced than the previous season. With reduced local supply and unchanged demand, prices rise for consumers, and imports also become more expensive.
Geopolitical tensions, election years, armed conflicts, or changes in trade policies of commodity-producing or exporting countries can disrupt supply chains and increase price volatility.
This is evident in the Ukraine war. Global initiatives were put in place to mitigate the negative consequences on the circulation of basic products such as grains, which the countries involved in the conflict are important producers and exporters of.
Among these initiatives was the agreement for the transit of Ukrainian grains through the Black Sea, signed by the United Nations and Turkey in July 2022, allowing Ukrainian grain exports. However, the agreement was terminated this year, creating even more uncertainties.
- Economic Policies
Changes in government economic policies often have repercussions throughout the commodities market.
To understand this, we suggest reading our article on the Chinese real estate sector issue. China’s market is not sufficiently heated with current fiscal and monetary incentives, leading to a decrease in real estate investments and significantly impacting the need for oil imports.
- Inventories and Storage
Inventory levels and storage capacity play a role in volatility. Low inventory levels make the market more sensitive to supply disruptions. Excess products tend to increase the need for storage and reduce selling prices for producers if demand does not keep pace with the same growth.
This is currently happening in Brazil: the country produces more than it can effectively store. With the prospect of a record grain harvest for 23/24, this issue is at risk of strengthening. We suggest reading this article to learn more about the Brazilian storage issue.
- Health Crises
Health crises, such as the COVID-19 pandemic, create uncertainties and lead to sharp movements in commodity prices.
This was an event that, like the Ukraine war, deserves significant attention because it clearly shows the impacts of volatility on the commodities market.
Below, we explain all the details.
Examples of How Volatility Impacts Global Commodity Prices
The COVID-19 pandemic and the conflict between Russia and Ukraine caused prices to rise in the commodities market and contributed to global inflation. Many countries experienced difficulties in dealing with the health crisis, and its consequences were exacerbated by the ongoing war.
- COVID-19 Pandemic
During the COVID-19 pandemic, many companies halted the production of commodities because people couldn’t go to factories to work. There were disruptions in logistics chains and competition to secure basic products, with concerns about reduced supply worldwide due to social distancing measures.
Commodity prices were impacted, and the effects of the pandemic are still felt today. Central banks in various nations moved to stimulate the economy by reducing interest rates. However, the increased availability of money did not accompany a proportional expansion of supply, a scenario that kept prices of several commodities high.
A situation of higher price inflation emerged worldwide, with authorities backtracking on their measures and starting to raise interest rates, creating the perfect scenario for an economic recession. Consumers felt this in their wallets, paying more for food and fuel.
- Russia-Ukraine War
Russia’s invasion of Ukrainian territory intensified existing concerns about the supply of food, energy, and inputs like fertilizers. Russia is a significant producer and exporter of natural gas and oil, while Ukraine has a strong presence in international grain trade. The potential reduction in supply further accelerated the value of commodities.
International commodity prices, as calculated by the International Monetary Fund (IMF), showed an increase in the early months of the conflict, especially in the prices of energy commodities and fertilizers (reaching extreme levels in April and May 2022).
In the graph below, you can observe the commodity price index from Jan/20 to Jan/23.
Risk Management: An Ally to Protect Against Volatility
Volatility cannot be eliminated since events are dynamic and sometimes unpredictable. However, there are tools that assist in managing risks in the commodities market.
To do this, it is essential to monitor trends and stay informed about all aspects that affect commodity prices. hEDGEpoint combines sophisticated hedge products with data analysis, which helps in making more informed decisions.
With professionals operating globally, we provide insights and contribute to generating more protection. Contact us to learn more!
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