How to Trade the Cyclical Nature of Natural Resources – Introduction
Natural resources are at the core of the global economic system. Without them, the current type of the global economy would not be there. For example, without crude oil, it would be impossible to travel around the world. Without copper, production of electricity would almost be impossible while without corn, wheat, soybeans, and cocoa, the world would not feed. Therefore, even the most technologically advanced countries like the United States, Singapore, and Hong Kong depend on the natural resources directly and indirectly.
The price of natural resources depends on the demand and supply. The rise in demand leads to the rise in price while the rise in supply leads to lower prices. This phenomenon happens in all types of commodities and is the backbone of the global economy. The natural resources are classified into several classes. Examples of agricultural commodities are wheat, corn, and soybeans while animal commodities are live cattle, lean hogs, and pork. Base metals are products like copper, tin, and zinc while precious metals are gold, silver, palladium, and platinum. Energy commodities are natural gas, crude oil, heating oil, and gasoline.
The movement of commodities are unique than other financial securities. For example, assume you are a corn farmer and the price of corn keeps falling, what will you do? Most farmers cut down the corn plantations and move to other agricultural crops. As they do this, they cause the supply of the crop to fall, which in turn leads to a higher price. For example, a few years ago, Kenya was a leading coffee producer. So, as the price of coffee fell, the farmers cut down their coffee plantations. This led to low supplies which saw the price of coffee futures rise. Other countries rushed to fill the gap caused by Kenya’s exit, which led to increased supplies.
A few years ago, as the price of crude oil fell, many oil and gas companies exited the industry voluntarily and involuntarily. Those which left voluntarily halted production to wait for prices to rise while the latter were forced into bankruptcies. This led to an opening, and the amount of crude oil stocks declined, leading to higher prices.
Therefore, natural resources are known as cyclical products in that a continued period of low prices leads to reduced supplies as producers exit the industry. On the other hand, when the prices are very good, producers tend to move to the industry in droves. As they move, they increase the supply, which leads to lower prices. This makes it impossible for the price of natural resources to continue moving higher for extended periods of time.
This is happening in the lithium markets. Last year, the price of lithium soared as traders expected more demand from the electric vehicles. Traders believed that lithium would become the next oil. As the price rose, the supply of lithium increased. Today, the lithium prices are falling and they are expected to fall further as supply outpaces supplies. The same happened last year with palladium, which was the best performing metal. It rose by more than 40%. This year, it has fallen by more than 15% as the supply has overperformed the demand.