Demonstration article

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Commodities are the raw materials of the global economy, and their prices are notoriously volatile. A drought, a strike at a mine, a conflict near a shipping lane or a shift in demand from a large economy can all send prices sharply higher or lower. The volatility is not random; it reflects distinctive features of how commodity markets work.

Inelastic supply and demand

In the short run, both supply and demand for many commodities respond slowly to price. A new mine or oil field takes years to develop, and crops are planted once a season. On the demand side, factories, power plants and households cannot quickly change how much fuel or metal they use. When neither side can adjust quickly, even a modest imbalance requires a large price move to clear the market.

Over longer periods, high prices encourage new supply and substitution, while low prices discourage investment, sowing the seeds of future shortages. This dynamic gives commodity markets their characteristic long cycles of boom and bust.

In commodity markets, the price is often the only thing that can move quickly.

Storage and the futures curve

Inventories act as a buffer. When stocks are plentiful, shortages can be met from storage, and prices stay relatively calm. When stocks are low, there is little cushion, and prices for immediate delivery can spike. The futures market reflects this. In a market with ample stocks, prices for future delivery typically sit above the spot price, compensating holders for storage costs — a pattern known as contango. When stocks are scarce, buyers pay a premium for immediate supply, and the curve slopes downward, known as backwardation.

Reading a commodity futures curve

Contango: future prices above spot, usually signalling ample supply.

Backwardation: spot above future prices, usually signalling tight supply.

Convenience yield: the benefit of holding physical stock when it is scarce.

Money, currencies and investors

Most major commodities are priced in dollars. When the dollar strengthens, commodities become more expensive in other currencies, which can dampen demand and weigh on dollar prices; a weaker dollar tends to have the opposite effect. Interest rates matter too: higher rates raise the cost of holding inventories and make commodities less attractive relative to interest-bearing assets.

Financial investors add liquidity and can amplify moves, although economists debate how much speculation influences prices beyond the short term. Producers use futures to lock in revenue and consumers to lock in costs, so markets serve a genuine hedging function. Longer-term forces — such as the energy transition, which may raise demand for some metals while eventually reducing demand for fossil fuels — shape investment decisions today, even though their effects will play out over many years.