Understanding Commodity Prices

Have you ever heard news stories about war causing oil prices to fluctuate, drought in a region affecting wheat prices or the demand for electric vehicles causing nickel prices to spike? These prices are all examples of commodity prices, which are regularly affected by local and global events that change the supply of commodities and the demand for them. Everyday consumers may be unacquainted with these prices, as we do not buy commodities directly.

Read on to get familiar with commodity prices and learn more about what commodities are, how their prices are valued, and which factors can cause those prices to change.

What Is a Commodity?

Basically, a commodity is a raw material or primary product that is considered interchangeable regardless of the producer and can be used as an input for finished goods and services sold to consumers. Usually, these materials are natural resources that can be extracted or grown directly from the earth. Commodities are broadly categorized as energy, metals or agricultural products. Examples include:

• Energy: oil, natural gas
• Metals: copper, steel, nickel
• Agricultural products: grain, dairy cattle, cotton

To further explain these materials’ role in goods and services, let’s look at the use of cotton in jeans and copper’s use in electronic devices. A consumer has little use for raw cotton but can use jeans. Copper as a metal is shiny but has little other utility for consumers. But when the copper is put into an electronic device, a consumer can now use the product to communicate, work or be entertained.

As mentioned in the definition, commodities are generally interchangeable. This means that regardless of who produces it, the material has a similar quality and function in making finalized goods.

Cotton picked in Arkansas and cotton picked in India can both be used to make jeans. Who produces the cotton doesn’t matter as much as who makes the jeans. The quality of the jeans will generally come down to how the producer uses the cotton: That’s why jeans are not considered a commodity. The methods of spinning, weaving, dyeing and sewing the cotton, along with other inputs like brass buttons, will change the quality of jeans more than the raw cotton’s source.

Commodities that Aren’t Raw Materials

There are some exceptions to the raw material rule for defining commodities. Secondary commodities—like steel, plastic and jet fuel—need other commodities for their production. The term “secondary commodities” indicates they are semi-finished rather than raw materials.

Because they are inputs, these materials are still considered commodities, even though the raw material is changed in creating them. Secondary commodities also are generally interchangeable and similar in quality: Steel smelted in Pittsburgh or steel smelted in Germany could be used in constructing a building.

How Commodity Prices Are Set

Even though consumers don’t buy commodities, commodities still have prices, as they require labor, time and capital to extract, and there is a demand for them to make products consumers will use. Understanding how these prices are set will help us better understand the cost of the goods we purchase.

Like most goods in a market economy, commodity prices are generally driven by supply and demand factors. If a severe drought in South America reduced the total grain available to the world, the price of a bushel of wheat would rise since there would be less grain available to meet demand. Likewise, if consumers in the United States, which has the largest volume of coffee consumed in the world, were to suddenly start drinking more tea than coffee, demand for coffee would shrink. In that case, the price of a pound of coffee could decline, as fewer beans would need to be roasted to meet demand.

Other factors that can shift supply and demand include geopolitical events, trade agreements, technological advancements, general economic conditions, weather and even investor sentiment on the future of a specified commodity.

How to Track Commodity Price Changes

To see a commodity’s price changes, you can track them online. In fact, many can be found in the St. Louis Fed’s online database FRED. In the FRED graph below, we can see how the global price of cocoa, measured in U.S dollars per metric ton, changed over time. We can see the price rose sharply in 2023. This was in part because there was a sharp decrease in the supply of cocoa from West Africa because of weather disruptions.Several other factors contributed, including crop disease and pests and speculation.

In the years that followed, many consumers noticed chocolate prices either increased or less chocolate was offered at the same price. This was due to the shortage of cocoa.

Understanding Commodity Prices Is Helpful

An understanding of commodity prices is a useful tool. Although the commodity price of uranium or fish meal might not be helpful knowledge for everyday life, other commodity prices—like we saw with cocoa—can be useful to know.

So, if you notice your morning coffee is more expensive, but everything else at the coffee shop is the same price, you might want to look at the commodity price of coffee beans and read the news. It just might be that coffee commodity prices have risen sharply in the last few years.Commodity prices may take a while to pass through to consumers, depending on the commodity, and a sustained and substantial rise or drop is usually required for producers to pass through the cost changes. Similarly, if you find gas prices at the pump lower, there is a chance oil prices have fallen.

Understanding commodity prices can help you be more informed about why prices of certain goods changed, and others did not.

Notes

1. Several other factors contributed, including crop disease and pests and speculation.
2. Commodity prices may take a while to pass through to consumers, depending on the commodity, and a sustained and substantial rise or drop is usually required for producers to pass through the cost changes.