Trading Commodities on News Releases
Fundamental or Technical?
In the world of trading, there are mainly two groups of traders: those who use technical analysis to guide their trading activities and those who believe fundamental analysis is the only reliable way. There is, however, also a smaller group of them who use both types of analysis.
Those who use technical analysis believe that the price of a trading instrument at any particular moment already incorporates all major news reports and that ‘trading on the news’ would result in you forever chasing the price.
Traders who trust in fundamental analysis, on the other hand, believe that there is no way to predict future price behaviour by simply using statistical formulas that rely on past price behaviour. They regard fundamental economic issues, such as GDP, inflation, supply and demand as vital to the price of any trading instrument.
Commodities and Market News
If one studies past price behaviour of commodities such as agricultural products and oil, it does become clear, however, that there is a correlation between price and a variety of factors.
The problem with using this to guide your trading activities is that it is very hard to attach a weight to any specific factor. News of a major oil discovery in one part of the world should under normal circumstances cause a drop in the oil price, but this might be completely offset by news of strong economic growth in a major world economy that is likely to result in increased demand for oil.
If you should decide to trade commodities on news releases, what type of information should you be looking at?
News Affecting Supply
Any major news that negatively affects the supply of a particular commodity will, everything else being equal, tend to increase the price. This may vary from a civil war in a major oil producing country such as Saudi Arabia pushing up the oil price to news from the weather bureau about a pending drought in South America affecting the supply of sugar, which will tend to push up the price of that commodity.
Even news about a major disaster hitting a large oil refinery could exercise significant upwards pressure on the oil price since it might well negatively affect supply in the near future.
Most countries keep stockpiles of important commodities such as oil and agricultural products. It makes sense that if a report suddenly reaches the market that the complete US stockpile of crude oil has been destroyed by an earthquake, it will have the immediate effect of pushing up the price of crude oil.
Large stockpiles on the other hand will tend to ease the pressure on prices and at least slow down price increases. Figures for US stockpiles of petroleum and crude oil are published regularly and many traders use these in conjunction with other market news to guide their trading activities.
News Affecting Demand
The price of a commodity is the balance between supply and demand at that particular moment. If news should reach the market that a very cold winter is expected in the Northern Hemisphere, we can expect the oil price to show an increase virtually immediately
Real life trading is, however, seldom that simple. If the European Central Bank should at the same time issue a warning about a looming recession in the EU, the net effect could well be for the price of oil to decline in anticipation of weaker demand.
The US Dollar
Where the price of a commodity is measured in US Dollars, its fate is irrevocably linked to that of the dollar. Any news that could lead to a weaker dollar, for example, could also push up the price of that commodity to compensate sellers. A weak dollar could, for example, lead OPEC countries to increase the price of crude oil.
Let us look at Fig 11.04(a), which reflects the daily price of Brent. On the 3rd and 4th of August 2011, the price of Brent Crude fell from 115.70 to a low of 107.00. What caused this major drop in the price?
If we study the world news for that week, we see headlines shouting: “Asian markets plunge on back of Euro fears and US losses.” and “Dow Jones Industrial Average falls by 512 points in biggest one-day fall since late 2008.”
In other words, the news of the day reflected a very gloomy outlook for the major economies of the world. This would in turn negatively affect demand for oil, hence the sharp price decline.
If we study Fig. 11.04(b) (the daily price of Sugar), we see that the price has eased from a high of 27.13 on the 28th of October to a low of 25.28 on the 1st of November 2011. Why did this happen?
The major reason seems to be that anticipated output from the world’s biggest sugar producer, Brazil, is better than expected. Combined with lower than expected demand from the food preparation and manufacturing sectors, this led to a drop in prices.
If you had closely followed the news, you might well have anticipated this and entered into a short trade, which would have meant a nice profit by now.