Worth 5 marks of 100Book pages 218 to 227About 30 minutes
A commodity has no balance sheet. Its price comes from supply and demand, the US dollar, the weather and politics. Users protect themselves by hedging.
Chapter mapNine short parts. 11.9 (hedging) has the only numerical. Tap to jump.
Equity analysis studies the company's financial statements, the industry and the economy. Fundamental analysis of commodities depends mainly on the supply and demand of that particular commodity. Chapter 4 (4.7) gave a first look; this chapter goes further.
What drives supply and demand11.1.1 and 11.1.2
Supply side
Production levels: crop yields, mining output, oil drilling capacity
Weather and natural disasters: droughts, floods, hurricanes
Seasonality: fuel in winter, crops after harvest, festive spikes
Country-specific factors (book examples)
Copper is largely produced in Chile. Weather problems and labour strikes there affect world supply.
Crude oil comes largely from North America, the Middle East and Russia. Middle East tension affects supply worldwide; the Russia-Ukraine war affected Russian crude supply.
On the demand side, a growing economy raises a country's consumption of gold and silver.
11.2 Major producers and consumers
Prices also depend on the health of the main producing and consuming countries: their economies, weather and political stability. Slowing growth or political instability in a key producing region can constrain supply and upset global balance. Trade sanctions, currency volatility and trade policies add to the swings.
The big playersFootnote in the book, citing the World Gold Council (June 2025) and the EIA
Largest producers
Largest consumers
Gold
China, Australia, Russia, USA, Canada
China, India, USA, Germany, Saudi Arabia
Crude oil
USA, Russia, Saudi Arabia, Canada, China
USA, China, India, Germany, Japan
11.3
The dollar and the dollar index
Countries trade commodities across borders: those with a surplus export to those short of it. Settling in many currencies creates currency risk, so the world settled on quoting and settling in a few easily convertible currencies. Since the post-war period, the US dollar has been the preferred one, and central banks hold it as a reserve currency. Commodities trade mostly in US dollars, followed by the euro.
To see the overall movement of the dollar in one number, analysts use the dollar index: the strength of the US dollar against six major currencies.
The six currencies in the dollar index
Euro
Japanese yen
Pound sterling
Canadian dollar
Swedish krona
Swiss franc
When the dollar moves, commodities move the other way
Dollar strengthens
Commodities cost more for buyers paying in other currencies. Global demand falls, pushing commodity prices down.
Dollar weakens
Commodities look cheaper in other currencies. Demand rises, pushing prices up. A weaker dollar often supports gold and crude oil.
Emerging markets with weak currencies pay more for dollar-priced imports, which feeds inflation and changes consumption.
Exporters of commodities can gain when their own currency weakens: their dollar revenue converts into more home currency.
Think of the dollar as the price tag's language. When the dollar gets stronger, the same tag costs an Indian buyer more rupees, so they buy less, and sellers cut prices.
11.4 Global and domestic markets move together
Organised commodity exchanges started in the mid-19th century and became global hubs that now set benchmark prices. Products on Indian exchanges are replicas of global ones, so their prices strongly correlate with international prices.
Global benchmark exchanges
Agricultural
CBOT
Chicago Board of Trade
Bullion
COMEX
Energy
NYMEX
New York Mercantile Exchange
Base metals
LME
London Metal Exchange
Crude oil on NYMEX directly affects fuel prices and inflation in importers like India. Indian base metal prices closely follow the LME.
A weakening rupee makes imports dearer and amplifies a global price rise.
Strong local demand, government action and seasonal supply can make domestic prices diverge from international ones for a while.
Match the exchange to the commodity: CBOT, agri; COMEX, bullion; NYMEX, energy; LME, base metals.
11.5
Crop and weather reports
Crop reports, from government agencies or research bodies, give acreage, planting progress, yield estimates, production and stocks of crops such as wheat, corn, soybeans, cotton and pulses.
Production higher than expected
Prices generally fall
Production lower than expected
Prices can rise
Weather reports matter because crops are highly sensitive to rain, temperature, drought, floods and frost. Book examples: a delayed monsoon in India hits rice and sugarcane; bad weather in Brazil disrupts coffee and soybean. Traders watch short-term forecasts and long-term patterns such as El Niño and La Niña.
11.6 Inventory, production and consumption
Three data sets that show the balance
Inventory
Stock held in warehouses, exchanges or government reserves. High stock signals oversupply, so prices fall; low stock signals scarcity, so prices may rise.
Production
How much is supplied. Shaped by technology, policy, seasons, geopolitics. More OPEC output pushes crude down; less mining lifts base metals.
Consumption
Demand: industrial use of metals, energy use, changing diets in emerging economies. Demand rising faster than supply pushes prices up.
11.7
Macroeconomic indicators
Commodities are raw materials for industry and essentials for consumers, so their prices are tied to the wider economy.
How the economy moves commodity prices
Indicator
Effect on commodities (as per the book)
GDP growth
Strong growth raises demand for energy, metals and farm goods. Slowdown or recession cuts demand, often lowering prices
Inflation
Rising inflation pushes investors to commodities, especially gold as a hedge. It also raises production and transport costs
Interest rates
Low rates encourage borrowing and spending, lifting demand. Higher rates strengthen currencies and often reduce commodity prices
Trade balance and geopolitics
Import-dependent countries pay more when supply chains break; export curbs tighten world markets
Employment, sentiment, industrial production
Show the underlying trend in demand
11.8 Government policies and geopolitics
Uncontrolled cross-border trade can hurt local producers and the trade balance, so governments use trade policy to protect the domestic market.
Government policy
Import-export rules, subsidies, tariffs and quotas decide how much enters or leaves
An export ban on wheat or rice tightens world supply, raising prices
Fuel subsidies cut production costs, encouraging farm output
Stricter mining or emission laws can cut output of metals and energy
Rates, taxes and infrastructure spending shift industrial demand
Geopolitics
Conflict in oil regions such as the Middle East disrupts supply and lifts crude sharply
Trade wars and sanctions restrict flows of energy, metals and farm goods
Strikes or unrest in producing nations cause sudden shortages
Producer alliances such as OPEC output agreements shape pricing power
Tension over shipping routes or pipelines adds a risk premium
11.9
Hedging in commodities
Hedging means taking an opposite position in futures or options to offset possible losses in the physical (cash) market. It is used by producers, consumers, traders, importers, exporters and investors.
Two hedges from the book
Seller's hedge
A wheat farmer
Expects a harvest, so sells wheat futures in advance. If wheat prices fall by harvest, the gain on futures makes up the loss on the crop.
Buyer's hedge
An airline
Exposed to rising fuel prices, so buys crude oil futures to lock in its cost and protect profit.
The goalThe goal of hedging is not to make a profit. It is stable, predictable cash flows. But it needs careful planning: over-hedging or a wrong strategy can increase risk instead of reducing it. Transaction costs and margins also matter.
Hedging is insurance. You pay a little and give up some upside, so that a bad day does not ruin you.
11.9.1 Hedge ratio
The hedge ratio is the share of a position that is hedged with derivatives: how much of the price risk is covered.
Hedge ratio = correlation between spot and futures prices × (SD of change in spot price ÷ SD of change in futures price)
SD means standard deviation (Chapter 12).
The book's copper exampleABC Company makes copper wire. MCX copper contract: 2.5 tonnes.
Inputs
Correlation 0.9853. SD of spot changes 9.02. SD of futures changes 9.71
Hedge ratio
0.9853 × (9.02 ÷ 9.71) = 0.915
Quantity
For 100 tonnes of exposure: 91.5 tonnes
Contracts
91.5 ÷ 2.5 = 36.6, so 37 contracts
The book says ABC needs 500 tonnes a month, but its worked answer (91.5 tonnes, 37 contracts) is for 100 tonnes. At 500 tonnes the same ratio would mean 457.5 tonnes. The quiz does not use this mismatch.
Try it: hedge ratio and contractsDefaults are the book's numbers for 100 tonnes
hedge ratio
quantity to hedge
contracts (rounded up)
11.9.2 Advantages and disadvantages
Advantages
Risk reduction: lock in prices against adverse moves
Stable earnings and cash flows: easier budgeting and planning
Works like insurance for investors in volatile periods
Lets businesses focus on core operations
In thin-margin industries, can be the difference between profit and loss
Disadvantages
Cost: margins on futures, premiums on options
Caps gains if prices move favourably
Wrong strategy or wrong hedge ratio can increase risk
Needs specialist knowledge, monitoring and administration; may not suit small businesses
All exam traps in this chapter
Commodity fundamental analysis rests mainly on supply and demand, not financial statements.
Technology and infrastructure reduce supply risk; cost of production is a supply factor.
Substitutes (EVs for oil) and seasonality are demand factors.
Copper: Chile. Crude: North America, Middle East, Russia.
Slowing growth, political instability, sanctions, currency volatility and trade policy disturb global balance.
Commodities trade mainly in US dollars, then euros.
Dollar index: USD against six currencies (euro, yen, pound, Canadian dollar, Swedish krona, Swiss franc).
Stronger dollar: commodity prices tend to fall. Weaker dollar: they tend to rise.
A weakening domestic currency makes imports dearer and amplifies global price rises.
CBOT: agri. COMEX: bullion. NYMEX: energy. LME: base metals.