As a trader, you are always searching for new connections and factors that can help predict which way stock prices might go. People often use various indicators, trade volumes, charts, how fast prices are changing, and a company’s earnings to help figure this out. But another way to understand stocks is by looking at how they are connected to things we dig out of the ground like copper, gold, oil, and other minerals. These things are called commodities in finance. So, what makes commodities special as a type of asset?
Commodities have some unique qualities when it comes to how they are demanded, supplied, and priced. Firstly, their demand and supply can be highly affected by different factors. For instance, opening new mines or finding new uses for a commodity can greatly change how much its people want and how much is available. Secondly, unlike products with brand names, commodity prices are mostly based on how much people want them and how much is available. Prices stay steady when demand matches supply. But if demand or supply changes, prices can quickly go up or down. Thirdly, the global commodity market is huge, and there are lots of people like speculators, traders, and hedgers who are always involved in buying and selling commodities.
The next question that probably triggers in your mind is; how are commodities related to or do they influence stock prices?
Its prices have a unique influence on equity prices in two ways. Firstly, there are companies solely focused on commodities like aluminium, iron ore, copper, and zinc producers. Similarly, companies involved in oil extraction and gold mining also fall into this category. These are called output-sensitive stocks because their success is directly linked to commodity prices. They tend to perform well whenprices rise.
Between July 15, 2022, and January 16, the price of copper futures surged by 24%. Interestingly, during this exact period, the share prices of Hindustan Copper Limited not only surged but also outperformed, generating a remarkable 46% return.
The second group of companies affected by commodity prices are called input-sensitive stocks. These companies rely on commodities as raw materials for their businesses. For instance, the paint industry depends on oil as a key material. These companies tend to perform better when prices fall because it reduces their input costs.
The essential idea is to have both a commodity price screen and a stock price screen on your trading platform, which is not complex. Often, short-term views might not provide accurate insights and may only be useful for short-term trading. However, if there’s a visible long-term trend, such as the case with oil after 2014 or metals in 2017, you can take positions in stocks accordingly and benefit from the trend.
It is crucial to understand whether you are focusing on the impact on output, leading to an upswing, or on input, resulting in a downswing. Either way, this method is relatively straightforward and can be a reliable way to engage with the markets. Nonetheless, it’s important to note that the risks involved are entirely yours to manage.