The 7 C’s of commodities: a framework every trader should know

Commodities are at the core of our global economy. From the oil we use to run our cars to the wheat used to feed the world’s population, commodities are what make up the backbone of our global economy. However, it is not always easy to understand the commodity market. To simplify this, a comprehensive list of the 7 C's of Commodities has been developed by experts and commodity market analysts.

Cost

At the base of any commodity is its cost of production. Whether it is extracting iron ore, drilling for oil, or farming soybeans, it is the cost of production that sets a base price below which it is impossible to produce. This is an important aspect of commodities for traders, as it helps them understand when prices are at levels at which production is impossible, i.e., when there is a risk of supply being curtailed.

Cycle

Commodities are cyclical. A commodity will rise in price when demand is greater than supply, prompting investment in new production. Eventually, this new supply of commodities comes onto the market, causing prices to fall again. Understanding where a commodity is in its cycle is important for traders.

Currency

Commodities are priced in dollars worldwide. This means that there is a direct relationship between currency and commodity prices. A weaker dollar means commodities are priced at a discount for other countries, which can increase demand for them. A strong dollar can also negatively affect commodity prices.

Climate

Weather is one of the strongest forces in commodity markets, especially for food. Droughts, floods, and temperature fluctuations can destroy food supplies in an instant, causing commodity prices to rise. Climate change is also having a significant, long-term effect on commodity markets. It is changing everything from planting times to energy demand.

Consumption

Demand is the driving force behind the commodity market. The overall consumption pattern of the world, influenced by factors like population growth, urbanisation, and an increase in the standard of living, particularly in developing countries like China and India, will decide how much of a particular commodity is required by the world. Changes in consumption patterns, like the increased use of electric cars that could reduce oil consumption, could redefine the price of a particular commodity sector.

Capacity

Supply capacity is the ability of producers to supply the current and future demands of a particular commodity. It is usually a combination of existing production capacity, excess capacity available for use, and capacity that is being developed. A situation where supply capacity is tight is a clear indicator of an increase in prices, whereas a situation where supply capacity is in excess will lead to a fall in prices. A strong indicator of supply is an increase in investments in developing new capacity.

Conflict and geopolitics

Political instability, trade wars, sanctions, and conflict may have a significant impact on commodities markets. Large commodity-producing countries, such as the Middle East for oil or Eastern European countries for grains, are often at the centre of geopolitical tensions. Conflict or sanctions may cause a sharp rise or fall in prices.

Conclusion

The 7 C's: Cost, Cycle, Currency, Climate, Consumption, Capacity, and Conflict provide a valuable framework for understanding a commodity market. None of these factors exists in a vacuum; they are constantly interacting with one another. The savvy commodity investor understands this dynamic interplay and seeks to use it to his or her advantage.

Regardless of whether you are a seasoned commodities investor or just starting to learn about the world of commodities investing, keeping these seven factors in mind will help you become a better commodities investor and a better decision-maker in one of the most dynamic markets in the world.