There are three primary determinants of commodity prices: supply, demand and sentiment. In the near term, if supply exceeds consumption, commodity prices tend to fall. Sentiment, or the opinion of traders that either look to hedge commodity prices to try and smooth out production costs or speculate for profit, is another important indicator that is much more difficult to gauge. For the most part, excess supply conditions are driving prices of the below commodities lower. They happen to be the worst performers so far this year, which could be due in good part to negative sentiment because in a number of cases the price is well below what the fundamentals appear to support [for more commodity news and analysis subscribe to our free newsletter].
- Coal: According to recent statistics, coal is the worst performer so far in 2012. The Market Vectors Coal ETF (KOL), which tracks the Stowe Coal Index of leading coal producers in the United States and also globally, is down approximately 28% year-to-date. The Dow Jones U.S. Coal Index is down closer to 40% and illustrates the extent to which coal has fallen out of favor. The U.S. Energy Information Administration attributes the decline to lower demand, which stems directly from the drop in natural gas prices (see below for further details). Now that gas is more affordable, coal as an alternative energy source is much less attractive. A slowdown in China is seen as the main reason global coal demand is down.
- Coffee: Coffee prices are also down close to 28% so far this year, lagging the decline in coal by the slightest of margins. Back in May, prices hit their lowest points over the past three decades. The substantial drop was attributed to a boost in supply that is outstripping demand by a fairly wide margin currently. Additionally, coffee demand is only growing a couple of percent, which is below its average over the past decade. Uncertain global economic growth is seen as a contributing factor to the slower demand growth. Back in 2008, coffee consumption did fall, surprising a number of industry analysts because the daily coffee routine of millions of global consumers was previously thought to be much more recession-resistant [see also 50 Ways To Invest In Agriculture].
- Natural Gas: In one of the more widely followed commodity stories this year, domestic natural gas prices have fallen to historic lows. Prices fell below $2 per thousand cubic feet earlier this year, which was attributed to a warm winter. Coupled with what is expected to be a multi-year rally in U.S. production thanks to new exploration and production techniques, including the efficient but controversial hydraulic fracturing, or fracking, prices have plummeted nearly 27% so far in 2012.
- Platinum: Platinum pricing, as detailed by the First Trust ISE Global Platinum Index (PLTM), is down around 18% so far this year. An estimated 40% of platinum demand stems from automotive manufacturing and jewelry production, and both have experienced lower demand from slowing global growth. It comes down to the same interplay of supply and demand that is affecting the other struggling commodities in 2012. Right now, supply is outstripping demand [see also How to Trade Platinum Futures].
- Sugar: Raw sugar prices are down close to 12% so far in 2012 and qualify as the fifth-worst commodity performer. As with coffee, supply is currently above demand. For sugar, this imbalance has persisted for three straight years now. Commodity prices also include sentiment regarding future supply and demand levels. A number of industry analysts are suggesting that the low sugar prices probably project too much pessimism regarding the balance going forward, and there is risk that Brazilian production could come in lower than expected during the current harvest.
The Bottom Line
Near-term supply and demand imbalances are difficult to predict. Longer-term, demand trends are easier to discern, as are projected production levels. Sentiment remains as difficult to predict as ever. The three factors have combined to send the five commodities down dramatically, at least for the first eight months of the year.
Disclosure: No positions at time of writing.