Why Are Commodity Prices Falling?

Commodity prices are falling. Fast. But why are commodity prices falling if they’re already at five year lows?

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It’s not unusual to see seasonal downswings in commodity prices during the summer months, but the magnitude of this past week’s move is so broad that it’s not seasonal but macroeconomic factors leading the charge.

The movement clearly illustrates the relationship between the dollar, interest rates, and commodity prices. Interest rates are increasing.  Dollar is strengthening. Commodity prices are dropping.

The theory behind the movement is that when the Fed “prints money,” the money flows into commodities and pushes prices up – and alternatively prices fall when money becomes scarce.  But what, exactly, is the mechanism that causes this relationship to exist?

Increasing interest rates decreases the price of commodities in four ways:

  1. It increases the pace at which commodities are produced by increasing the incentive for extraction today rather than tomorrow.
  2. It decreases the producer’s desire to carry inventories.  Storage costs increase.
  3. Institutional investors shift investment out of commodities (high risk) and into treasury bills (low risk).
  4. Strengthens the domestic currency, which, in effect, reduces the cost of globally traded commodities.

Right now, monetary tightening is widely anticipated in the US, with the FOMC signaling that they will likely raise short-term interest rates sometime this year – most likely September. It’s not seasonality or an actual change, but the expectation of a rate increase that’s pushing commodity prices lower.

About Shawn Lucas

Shawn Lucas is the founder and fund manager at Apiary Fund. He began his career as a broker for Fidelity and Charles Schwab where he worked the trading desk and processed orders for high net worth investors. An expert in the field of technical and economic analysis of the financial markets, Lucas has since established his reputation as a thought leader and guest speaker for several financial companies including Reuters and TD Ameritrade. He has traveled extensively throughout the world providing lectures, training, consulting, and expert testimony to companies and individuals on the art and science of financial analysis. Lucas has authored sixteen books and studies on the use of technical and economic analysis in stock, option, and futures trading. His simple and methodical approach to the markets has helped thousands of investors better understand and improve their performance and profitability in the financial markets.

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