Commoditym&Its Pricing

Commodity prices are very persistent. During booms, we seem to forget that they have always (yes, always) been followed by busts. And, during a slump, we forget that a boom is surely going to come along — we just have to wait long enough. What determines such booms and busts?

Three aspects of commodity theory should not be overlooked. First, commodities can be stored, implying a trader can buy today and pay the costs (of financing that purchase and storage) and sell in the future. If traders are convinced China’s growth will rise in six months, boosting demand and the price of copper at that time, the price will rise today.

As China demands virtually every commodity, all prices will increase. Or, if a new chance arises that hostilities in the Middle East may disrupt oil next year, oil prices will shoot up today, and then if through some hasty diplomacy the problem is solved, prices will fall — all without a single shot being fired. In effect, forward-looking commodity prices respond to the probabilities of future supply and demand events.


Demand shocks may provoke high correlations across commodities, whereas supply shocks tend to be more idiosyncratic. The second aspect is that prices can be very non-linear.… High prices stimulate investment.… Whatever the micro-foundations, a third aspect is that commodities do seem susceptible to price and investment booms, followed by crashes, and then supply slowly readjusts.

From “Commodity Prices: Over a Hundred Years of Booms and Busts”