What is a Commodity?
It can be described as a “physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts.” (Investor Words)
So, corn is as much a commodity as Gold and Silver. If these are tangible substances, unlike stocks and shares per se, why does the price fluctuate quite so much as they do? In answering this question we need to further understand the forces affecting the possible price changes in precious metals.
1. Supply and Demand
This first reason is as old as the bartering system of past empires. Due to the inclement weather (or rather, the beautiful snow) here in the UK last week, several basic food items ran out in the supermarket even before the snow arrived. This was simple supply and demand – if every person bought 4 cartons of milk in preparation instead of 3 then the computer re-ordering model for the supermarket becomes out of sync within minutes and empty shelves rapidly ensue. This is the reality of supply and demand.
There is also the ‘perception’ of supply and demand. If people perceive that there will be a shortage, whether that transpires or not, there will be a self-fulfilling shortage. Some intense rises in the price of Gold and Silver have worked precisely on this basis.
But, in reality, Gold and Silver do become affected by mining supplies. There will be a slower delay, obviously, for this to filter through to the price the investor pays. But, keeping an eye on how the mining industry is going and specifically, how Gold and Silver mining companies are faring around the globe, is a smart investor – able to predict both the bottlenecks or scarcities of supply coming up through the pipes of the precious metals market.
It is a well-known fact that human psychology affects the financial markets. If the general populace and the traders believe a product will give a large return, then more people enter that market, temporarily pushing up the price. This was incredibly evident recently within the crypto-currencies. As soon as the mainstream commentators started covering the price rise in Bitcoin, the price exploded upwards in an exponential manner. It exploded because greed led many, many investors to follow the crowd into the “next big thing.”
The opposite effect to the above and its mirror. As quickly as the price of Bitcoin rose, it fell, and spectacularly. That is because fear spreads at an equally exponential rate as does greed. It takes a cool smart head to move against the crowd and exit the door as the crowd is pushing in. Most humans aren’t made that way. This is why thorough research and attention to and understanding of facts is a wise skill to acquire. Bleyer’s CEO, Caroline Peers, for example, is very well versed in watching financial precious metal charts. It is one of my first memories of her, sitting opposite at our desks, aware she was refreshing the Gold price charts way more often than the rest of us. Caroline will also look for patterns in these charts and uses this approach when considering the behaviour of prices, she sometimes comments on this activity in Bleyer newsletters.
Several fund managers and financial commentators obviously hold the same strength, as Caroline’s background came from city banking. Michael Howell, managing director at Crossborder Capital, said in a recent interview with Kitco News “that he considers any dip in the gold price as a long-term buying opportunity. We have been telling clients to buy Gold on weakness because it will be higher in 18 months,” he said. “On the whole, the entire financial background has to be positive for Gold.”
4. Geo-Political Developments
This is a theme covered strongly in the ‘Monthly Round Up’ articles here at Bleyer and across the internet. This month, for example, “after U.S. President Donald Trump said he would push ahead with punitive tariffs on imports, rekindling fears of a potential trade war” (CNBC) the price of Gold rose. This is because, as many of our readers are aware, Gold is considered a safe haven investment in times of geo-political uncertainty.
5. Quantitative Easing and Currency Problems
To briefly reiterate a term discussed at length in previous articles, currency is just the paper we hold which we tend to think of as ‘money’, while Gold is considered the ‘real money’, a product of inherent worth. A paper note is not worth £5, £10, £20 or £50, it is simply a promissory note, worth only the cost of the paper and ink. So, when the Federal Reserve, the Bank of England or the European Central Bank announce the ‘creation’ of millions more of these notes, the tradable value of each one slowly falls in relation to real items, such as bread, corn and gold. This is what is known as the “traditional quantity theory” which “usually assumes that velocity, the average frequency that a banknote or deposit changes hands, is quite stable. So when M – the money supply – increases, a hot potato effect emerges. Anxious to rid themselves of their extra money balances M, people race to the stores to buy Y, goods and services, that they otherwise couldn’t have afforded, quickly emptying the shelves. Retailers take these hot potatoes and in turn spend them at their wholesalers in order to restock. But as time passes, business people adjust by ratcheting up their prices so that the final outcome is a permanent increase in P.” (Commodity Trade Mantra)
We hope this brief overview of just five of the reasons the price of commodities fluctuates will give a little spring clean to the focus our readers enjoy as you read the news and watch the markets. In addition, don’t forget there is still time to quickly purchase a little Gold or Silver for Mothering Sunday (dependent on stock).