Three Factors Pushing Commodity Prices

In previous articles, I specifically laid a foundation on the basics of commodities: what they are, how they’re traded, and what their key risks are. Now it’s time to get down to the nuts and bolts of factors that influence a commodity’s price movement.

As we’ve discussed, there are several elements that can cause commodity prices to change, with the most important being shifts in supply and demand for a commodity. That is, how much or how little of a given commodity is available for supply and the degree to which it’s in demand. Thus, when it comes to our ability to project future price changes, it’s essential to obtain reliable information about the current and projected future levels of supply and demand.

One way to tap into this information is by identifying what the largest and most informed market participants are buying and selling.

Commitment of Traders (COT) Report

The Commitment of Traders (COT) is a weekly report issued by the Commodity Futures Trading Commission (CFTC) that highlights the change in holdings for specific participants in a number of futures products in the United States. Submissions of positions are delivered to the CFTC by participants who hold positions that are large enough to meet reporting levels established by the CFTC for each futures product. The report is measured on the close of trading Tuesday and then released Friday afternoon. Having access to this type of information is very useful for traders, as it focuses on participants who are most likely to be the best informed.

The COT report is broken down into three categories:

• Reportables* (Non-Commercial) – Large Traders: Smart Money

• Reportables (Commercial) – Producers & Hedgers: Generally Not Useful

• Non-Reportables – Small Traders: Not Smart Money

*Reportables are the largest group, representing about 70% – 80% of outstanding futures positions.

The first group is the Non-Commercial, or smart money, group, which represents large traders like hedge funds and institutions. This is the key group to focus on. There are a couple of reasons why traders follow this group for signs of accumulation. First, due to the size that these businesses have been able to grow to, they’ve likely had good past performance in the markets. In addition, their research budgets would be substantially larger than the vast majority of small traders, providing them with much better information.

Next is the Commercial group, which represents the producers and farmers of commodities. They use the futures market to hedge the risk of price fluctuations on their products. This group is generally not a relevant source to follow, as they’re not trying to make money in the commodity market, but simply hedging the risk of commodity price changes. Thus, it’s likely that this group loses money in the futures market, only to gain it back in the market that they exchange the actual underlying commodity in, known as the cash market.

Lastly, Non-Reportables are the small traders who are often the least informed group, and therefore, frequently tend to make wrong market decisions. This group is often used as a contrarian indicator for that reason. If they’re buying, then that commodity may be more likely to experience future weakness. Conversely, if they’re selling, then the commodity may begin to show signs of price strength. You may be thinking about how this number is derived since it’s not reported to the CFTC. The number is obtained by subtracting all reportable positions from the total positions.

Conclusion

There are a lot of analysts and experts that provide us with commentary for the commodity market, but being able to track what the largest traders are actively buying and selling can be significantly more useful. When and where the largest players are moving their money is a measure of the commitment and conviction they have in the future direction of a commodity.

Understanding and tracking the COT report is an optimal way of gauging commodity buying or selling sentiment, which helps us answer the question of where the markets largest participants are seeing weaknesses or opportunities.

In the next article, we’ll go through the process of reading the COT report, which can be found here.

This article is for educational purposes only and is not a recommendation or endorsement of any particular investment or investment strategy. Investools does not provide financial advice and is not in the business of transacting trades.

The risk of trading futures can be substantial. The valuation of futures may fluctuate, and as a result, investors may lose more than their original investment. Investors must consider whether futures are a suitable investment for their own personal financial situation before trading. Past performance is not indicative of future results.

Links to third-party content are provided for informational and/or entertainment purposes only and are not an indication of endorsement, sponsorship, approval or affiliation. The views and opinions expressed in third-party content are solely those of the third-party. All third-party content is the property of its respective owner(s).

Photo credit: public domain